Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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US Dollar, Treasury bonds in focus
John J. Hardy
Chief Macro Strategist
The most interesting development this week would be strong US Treasury auctions that see a sharp drop in US yields as a test of the recent weak USD trend. On the risk appetite front, note that the highs on Friday near 2,750 are near a critical Fibo retracement level for the S&P 500, so that level looks pivotal for the next leg of market action.
The two key factors for the action from here are the state of risk appetite and the US treasury market, which faces an important test this week with three large auctions of two-, five-, and seven-year Treasuries on Tuesday through Thursday and the latest Federal Open Market Committee minutes on Wednesday. The big surprise many noted last week was the fresh highs in US yields failing to derail the ongoing equity market recovery.
On the currency side, the narrative is that the US dollar can continue to fall as US interest rates rise because the rise in US yields reflects concerns on the US fiscal/current account balance sheet more than it reflects a strengthening US economy. The US 10-year benchmark came within hailing distance of the huge 3.00% level last week, widely considered a critical structural chart point – it is hard to believe, last week’s action notwithstanding, that a persistent rise above this level would be met with a shrug by asset markets, from equities to emerging markets.
The most interesting development this week would be strong US treasury auctions that see a sharp drop in US yields as a test of the recent weak USD trend. On the risk appetite front, note that the highs on Friday near 2,750 are near a critical Fibo retracement level for the S&P 500, so that level looks pivotal for the next leg of market action.
Chart: EURUSD versus the S&P 500
The recent market action suggests there is a rough directional correlation of EURUSD and the S&P 500, something that is likely to continue as long as markets remain volatile as speculative positioning is relatively stretched (long EUR, short USD).
For EURUSD to continue to progress higher, we may need the recovery in risk sentiment to continue, which would allow for further build-up in positioning.
Elsewhere, the South African rand has remained the darling of EM, finishing last week near a three-year high against the US dollar as president Zuma resigned. Now begins the hard work of repairing the nation’s finances, a task that won’t be easy. A key event risk this week is Wednesday’s announcement of a new South African budget, which could give an indication of how seriously the new leadership is taking the need to repair the damage done.
The G-10 rundown
USD – the bounce on Friday came from the edge of the abyss in EURUSD and USD Index terms. It seems that the most supportive combination for the greenback this week would be a strong bond auction and return of risk aversion as it would challenge the narrative on two fronts.
EUR – the 1.2500 level is proving a tough nut to crack for EURUSD as big round levels are often cause for pause in this super-major. Recent market action suggests that this pair is more tightly correlated with the rise and fall in risk appetite, perhaps as long EUR and short USD are strong consensus trades.
JPY – we discussed the risk of a significant breakdown in USDJPY recently, but have been surprised at the vigorousness of the move even as risk appetite staged a significant recovery last week. Hard to believe that broad JPY strength continues here if we continue to see strong risk sentiment.
GBP – sterling remains locked in the range versus the euro, as we await further signs from the Brexit front, apparently. Some earnings and employment data on Wednesday the data highlight of the week for the UK.
CHF – a bit surprising that EURCHF didn’t rebound more enthusiastically to the bounce in risk sentiment, suggesting perhaps lingering concerns about the March 4 Italian election and the German SPD party vote on the grand coalition the same day.
AUD – the AUD saw a weak close on Friday, but the key commodity prices for Australia have rebounded recently. The bears in AUDUSD can keep their hopes alive if we remain below 0.8000, though better confirmation would be a strong drop back through 0.7750.
CAD – USDCAD has put in a bounce near the 21-day moving average, as the pair remains in limbo and the 200-day moving average is declining towards the top of recent price action soon. Bulls need a close above the 1.2600-50 area to argue for an upside break, as well as perhaps a fresh sell-off in crude oil. Canada Retail Sales and CPI up on Thursday and Friday this week, respectively.
NZD – the strong kiwi has been interacting with its 2018 highs above 0.7400, the last resistance zone ahead of 0.7500+. We have long-term valuation concerns on the kiwi, but no visibility on what would spark a sell-off as the currency largely escaped the recent bout of volatility.
SEK – key test for EURSEK tomorrow if the market backdrop is quiet as Sweden reports CPI.
NOK – EURNOK tilting back lower on recovery in risk appetite and crude oil. The 200-day moving average has risen to the bottom of the range this year just above 9.50 – making this are pivotal for downside prospects.
The G-10 rundown
USD – the bounce on Friday came from the edge of the abyss in EURUSD and USD Index terms. It seems that the most supportive combination for the greenback this week would be a strong bond auction and return of risk aversion as it would challenge the narrative on two fronts.
EUR – the 1.2500 level is proving a tough nut to crack for EURUSD as big round levels are often cause for pause in this super-major. Recent market action suggests that this pair is more tightly correlated with the rise and fall in risk appetite, perhaps as long EUR and short USD are strong consensus trades.
JPY – we discussed the risk of a significant breakdown in USDJPY recently, but have been surprised at the vigorousness of the move even as risk appetite staged a significant recovery last week. Hard to believe that broad JPY strength continues here if we continue to see strong risk sentiment.
GBP – sterling remains locked in the range versus the euro, as we await further signs from the Brexit front, apparently. Some earnings and employment data on Wednesday the data highlight of the week for the UK.
CHF – a bit surprising that EURCHF didn’t rebound more enthusiastically to the bounce in risk sentiment, suggesting perhaps lingering concerns about the March 4 Italian election and the German SPD party vote on the grand coalition the same day.
AUD – the AUD saw a weak close on Friday, but the key commodity prices for Australia have rebounded recently. The bears in AUDUSD can keep their hopes alive if we remain below 0.8000, though better confirmation would be a strong drop back through 0.7750.
CAD – USDCAD has put in a bounce near the 21-day moving average, as the pair remains in limbo and the 200-day moving average is declining towards the top of recent price action soon. Bulls need a close above the 1.2600-50 area to argue for an upside break, as well as perhaps a fresh sell-off in crude oil. Canada Retail Sales and CPI up on Thursday and Friday this week, respectively.
NZD – the strong kiwi has been interacting with its 2018 highs above 0.7400, the last resistance zone ahead of 0.7500+. We have long-term valuation concerns on the kiwi, but no visibility on what would spark a sell-off as the currency largely escaped the recent bout of volatility.
SEK – key test for EURSEK tomorrow if the market backdrop is quiet as Sweden reports CPI.
NOK – EURNOK tilting back lower on recovery in risk appetite and crude oil. The 200-day moving average has risen to the bottom of the range this year just above 9.50 – making this are pivotal for downside prospects.
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