Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Weak transmission to FX from risk swings
John J. Hardy
Chief Macro Strategist
Summary: The gyrations in equity markets are seeing rather weak transmission into the currency market as it seems only the Japanese yen is paying attention to intermarket developments. We won’t really know the lay of the land until Friday.
Yesterday revealed that the FX markets are reluctant to draw strong conclusions from the gyrations in the equity markets over concerns that the US-China trade negotiations are on the rocks. It is rather clear in the meantime that the JPY is the safe haven of choice when risk sentiment weakens badly and that the US dollar is rather neutral.
But it is also clear that we shouldn’t draw conclusions just yet about where all of this will lead and we have a lot of pent up energy ahead of Friday, when we assume we get an announcement on the status of both the tariffs threatened to go into effect and the temperature of relations.
Best case at this point: a delay of tariffs and suggestion that the sides can work towards a deal. Worst case: one of the sides walks away from the table and hostile language emerges from both sides. This is the short term, for the longer term, the relationship between the two powers risks turning into a rivalry or worse, so the upside beyond tactical headline response should be taken with this longer-term trail of salt grains in mind.
Besides the immediate trade issue dogging investor sentiment, the chief driver has been the switch to a more dovish policymaking stance and whether the Fed is set to cut rates sooner rather than later and whether those cuts come ahead of signs of an actual growth slowdown (the Fed ahead of the curve) or that the Fed has already hopelessly over-tightened policy and the rate cuts will be too little, too late.
One thing is clear to me: a bad outcome this Friday in trade negotiations could lead to weak sentiment that elicits a quick and large policy response – a 50-bps chop to the rate at the June Federal Open Market Committee meeting, for example. That’s a scenario, not a prediction – we’ll revisit after Friday.
Overnight, the Reserve Bank of New Zealand did deliver the rate cut we expected, but the outlook remained fairly upbeat and the policy forecast for the official cash rate through Q3 of next year suggests the bank only sees about 50/50 odds for another rate cut between now and then. So the kiwi has bounced strongly after the kneejerk lower.
Trading interest
Squaring NZD shorts – RBNZ not sufficiently dovish.
Looking at short term USDJPY calls for a risk-friendly immediate outcome to US-China trade talks – 2-week 110.75 calls cost about 30 pips with spot trading 110.15 this morning.
Looking at 1-month EURCHF calls, strike 1.1450 – cost around 40 pips this morning with spot trading 1.1415
Chart: USDJPY
The yen is one of the few things moving in the currency space this week – USDJPY has managed to clear the first key supports and is staring down the last bits of the range just below the psychologically important 110.00 level. The JPY crosses likely to react with the highest beta to US-China trade talk outcome this Friday – certainly two risks.
But it is also clear that we shouldn’t draw conclusions just yet about where all of this will lead and we have a lot of pent up energy ahead of Friday, when we assume we get an announcement on the status of both the tariffs threatened to go into effect and the temperature of relations.
Best case at this point: a delay of tariffs and suggestion that the sides can work towards a deal. Worst case: one of the sides walks away from the table and hostile language emerges from both sides. This is the short term, for the longer term, the relationship between the two powers risks turning into a rivalry or worse, so the upside beyond tactical headline response should be taken with this longer-term trail of salt grains in mind.
Besides the immediate trade issue dogging investor sentiment, the chief driver has been the switch to a more dovish policymaking stance and whether the Fed is set to cut rates sooner rather than later and whether those cuts come ahead of signs of an actual growth slowdown (the Fed ahead of the curve) or that the Fed has already hopelessly over-tightened policy and the rate cuts will be too little, too late.
One thing is clear to me: a bad outcome this Friday in trade negotiations could lead to weak sentiment that elicits a quick and large policy response – a 50-bps chop to the rate at the June Federal Open Market Committee meeting, for example. That’s a scenario, not a prediction – we’ll revisit after Friday.
Overnight, the Reserve Bank of New Zealand did deliver the rate cut we expected, but the outlook remained fairly upbeat and the policy forecast for the official cash rate through Q3 of next year suggests the bank only sees about 50/50 odds for another rate cut between now and then. So the kiwi has bounced strongly after the kneejerk lower.
Trading interest
Squaring NZD shorts – RBNZ not sufficiently dovish.
Looking at short term USDJPY calls for a risk-friendly immediate outcome to US-China trade talks – 2-week 110.75 calls cost about 30 pips with spot trading 110.15 this morning.
Looking at 1-month EURCHF calls, strike 1.1450 – cost around 40 pips this morning with spot trading 1.1415
Chart: USDJPY
The yen is one of the few things moving in the currency space this week – USDJPY has managed to clear the first key supports and is staring down the last bits of the range just below the psychologically important 110.00 level. The JPY crosses likely to react with the highest beta to US-China trade talk outcome this Friday – certainly two risks.
The G10 rundown
USD – status for the USD not available until after Friday’s announcement of whatever stripe from the US-China trade talks. Doesn’t seem to do well as safe haven at the moment (positioning a driver there?).
EUR – the euro neutral here and hard to get excited about upside prospects, outside, perhaps of EURCHF if the pair shakes loose of the range.
JPY – will react with the highest beta to Friday’s trade talk headlines – can only thrive in the teeth of intense risk sentiment weakening, as we all know that BoJ ready to eventually defend.
GBP – sterling rally backing off as it should, given widespread uncertainty elsewhere. Don’t see how May can move the Brexit process forward at all. Downside risks prevail.
CHF – some interest here, given the market should have thoroughly discovered by now that CHF not working as a safe haven currency – then why does the longer term level price it as such? Will watch for technical break higher in EURCHF clear of 1.1450-1.1500.
AUD – the Aussie hanging in there despite the risk off – clearly the CNY providing an anchor and this may make AUD untradeable or worse for the AUD bears as long as USDCNY is in lockdown.
CAD – USDCAD bulls still have an argument, but we need a breakthrough higher in USD after Friday - USDCAD in a 250-pip range for over two months now.
NZD – the optimistic outlook from the RBNZ a real disappointment and NZD bears may be disappointed here unless the testimony tonight from RBNZ’s Orr brings new twists to light – but he had a chance at presser overnight to do the same.
SEK – SEK to take its cue from risk sentiment and risks from any fallout from a negative outcome on Friday’s US-China trade talks – Yesterday’s EURSEK close was 9-year+ high.
NOK – Norges Bank up tomorrow and NOK vulnerable if Norges eases away from its hawkish stance – 10.00 in EURNOK likely to heave quickly into view if oil down, US-China trade talks bring negative sentiment, etc.
Upcoming Economic Calendar Highlights (all times GMT)
1130 – ECB President Draghi to speak
1215 – Canada Apr. Housing Starts
1230 – Fed’s Brainard (Voter) to speak
1430 – US Weekly DoE Crude Oil / Product Inventories
2000 – New Zealand RBNZ Governor Orr
2301 – UK Apr. RICS House Price Balance
USD – status for the USD not available until after Friday’s announcement of whatever stripe from the US-China trade talks. Doesn’t seem to do well as safe haven at the moment (positioning a driver there?).
EUR – the euro neutral here and hard to get excited about upside prospects, outside, perhaps of EURCHF if the pair shakes loose of the range.
JPY – will react with the highest beta to Friday’s trade talk headlines – can only thrive in the teeth of intense risk sentiment weakening, as we all know that BoJ ready to eventually defend.
GBP – sterling rally backing off as it should, given widespread uncertainty elsewhere. Don’t see how May can move the Brexit process forward at all. Downside risks prevail.
CHF – some interest here, given the market should have thoroughly discovered by now that CHF not working as a safe haven currency – then why does the longer term level price it as such? Will watch for technical break higher in EURCHF clear of 1.1450-1.1500.
AUD – the Aussie hanging in there despite the risk off – clearly the CNY providing an anchor and this may make AUD untradeable or worse for the AUD bears as long as USDCNY is in lockdown.
CAD – USDCAD bulls still have an argument, but we need a breakthrough higher in USD after Friday - USDCAD in a 250-pip range for over two months now.
NZD – the optimistic outlook from the RBNZ a real disappointment and NZD bears may be disappointed here unless the testimony tonight from RBNZ’s Orr brings new twists to light – but he had a chance at presser overnight to do the same.
SEK – SEK to take its cue from risk sentiment and risks from any fallout from a negative outcome on Friday’s US-China trade talks – Yesterday’s EURSEK close was 9-year+ high.
NOK – Norges Bank up tomorrow and NOK vulnerable if Norges eases away from its hawkish stance – 10.00 in EURNOK likely to heave quickly into view if oil down, US-China trade talks bring negative sentiment, etc.
Upcoming Economic Calendar Highlights (all times GMT)
1130 – ECB President Draghi to speak
1215 – Canada Apr. Housing Starts
1230 – Fed’s Brainard (Voter) to speak
1430 – US Weekly DoE Crude Oil / Product Inventories
2000 – New Zealand RBNZ Governor Orr
2301 – UK Apr. RICS House Price Balance
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