Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Yen on an explosive trajectory
John J. Hardy
Chief Macro Strategist
Summary: The USD is weak and the Japanese yen is drastically weaker as rising bond yields are absorbed by the currency rather than JGB’s which can’t move if the BoJ is to make good on its policy. The situation is fraught with danger in both directions.
The weak USD is getting a lot of the headlines here, but it is really the even weaker Japanese yen that deserves the bulk of our focus. Rising US long yields in an environment of strong risk appetite are driving the losses in JPY, as the currency must absorb the effect of widening yield spreads since the JGB market and its fixed – or at least capped – yields out to 10 years can’t do so under the Bank of Japan’s yield curve control policy.
If yields continue to head higher, we could see further dramatic pressure on Japan’s currency and an eventual chaotic situation if the BoJ is forced to fold its hand.
The Hong Kong dollar headed sharply stronger in its biggest single day move in years – not a big deal in percentage terms, but certainly a big deal in signaling that something is afoot in Asia. The other thing that is afoot is China allowing its currency to sharply weaken against the basket and against the euro, where the EURCNY has now leaped considerably above the 8.00 level. It will take a bit of time to understand China’s intent, but is the new policy to allow a weakening against the rest of the world while keeping the rate against the US dollar relatively stable?
Yesterday, Norges bank failed to deliver the more hawkish guidance that the market was pricing in, largely leaving the guidance unchanged for the end of 2019 and oddly, the consensus forecast was slightly lower for the next couple of quarters. NOK suffered a vicious sell-off, but that may not extend any further given the very supportive backdrop of strong risk appetite and a weaker USD helping to drive strong energy prices. The 9.60 area in EURNOK looks pivotal and is also near the 200-day moving average.
Emerging markets have found fairly strong support with the backdrop of a weaker US dollar and strong risk appetite, though we wonder how far the move can run as long as the US yield curve is lifting. The ZAR is sharply stronger after the SARB’s no-change decision yesterday and USDTRY tried to sell off a bit on a not-very-clear announcement from Turkey’s Finance Ministry, but Turkish credit spreads are sharply improved.
Chart: EURJPY
The USD is weak, but the JPY is much weaker still and any further rise in global bond yields seems to transmit straight into JPY weakness until the BoJ signals a change in its stance – making for a potentially chaotic situation. For now, EURJPY is running up into the six-month highs and the next resistance above doesn’t come in until the highs early this year around 137.50.
If yields continue to head higher, we could see further dramatic pressure on Japan’s currency and an eventual chaotic situation if the BoJ is forced to fold its hand.
The Hong Kong dollar headed sharply stronger in its biggest single day move in years – not a big deal in percentage terms, but certainly a big deal in signaling that something is afoot in Asia. The other thing that is afoot is China allowing its currency to sharply weaken against the basket and against the euro, where the EURCNY has now leaped considerably above the 8.00 level. It will take a bit of time to understand China’s intent, but is the new policy to allow a weakening against the rest of the world while keeping the rate against the US dollar relatively stable?
Yesterday, Norges bank failed to deliver the more hawkish guidance that the market was pricing in, largely leaving the guidance unchanged for the end of 2019 and oddly, the consensus forecast was slightly lower for the next couple of quarters. NOK suffered a vicious sell-off, but that may not extend any further given the very supportive backdrop of strong risk appetite and a weaker USD helping to drive strong energy prices. The 9.60 area in EURNOK looks pivotal and is also near the 200-day moving average.
Emerging markets have found fairly strong support with the backdrop of a weaker US dollar and strong risk appetite, though we wonder how far the move can run as long as the US yield curve is lifting. The ZAR is sharply stronger after the SARB’s no-change decision yesterday and USDTRY tried to sell off a bit on a not-very-clear announcement from Turkey’s Finance Ministry, but Turkish credit spreads are sharply improved.
Chart: EURJPY
The USD is weak, but the JPY is much weaker still and any further rise in global bond yields seems to transmit straight into JPY weakness until the BoJ signals a change in its stance – making for a potentially chaotic situation. For now, EURJPY is running up into the six-month highs and the next resistance above doesn’t come in until the highs early this year around 137.50.
The G-10 rundown
USD – the US dollar on its back foot even as the entire US yield curve lifts higher as the new widening of yield spreads doesn’t seem to be a source of strength. The USD could run a bit lower given positioning, but eventually, some yield convergence would seem necessary to see further declines. Hard to see how the Federal Open Market Committee surprises next week unless it is in a dot plot shift higher, and the market seems to be absorbing higher US yields anyway.
EUR – the euro clearing the 1.1725-50 area in the EURUSD chart and having a look at flash Eurozone PMI’s this morning (a brief test above 1.1800 was brushed back after the French survey came in a bit soft, but these may not hold back the euro this morning). There may be room for the EURUSD to run higher into the 1.2000 area assuming the FOMC meeting next week gives no surprises.
JPY – the JPY driver is clear, but the action may prove very treacherous and could end in a climactic reversal, either because yields stop rising or the BoJ offers hints on policy at some point. Consider the ugly place that the Bank of Japan finds itself in as outlined in this Bloomberg piece.
GBP – sterling headline risk in constant evidence here as the Brexit negotiations are stalled hopelessly on the Irish border issue and sterling has backed down sharply after surging again yesterday on strong Retail Sales data. Next weekend sees the Tory party conference, another key test of the political temperature.
CHF – the Swiss franc is sideways, a bit surprising given the backdrop, but we did have a slight widening of Italy-core spreads as the FSM’s leadership is not happy with the amount of funding in budget proposals for issues it champions.
AUD – the AUDUSD chart bumping up against the descending channel top – more CNY strength, strengthening risk appetite and commodity strength needed to extend the squeeze – perhaps to the 0.7500 level, though we haven’t changed our position on longer-term negative risks.
CAD – USDCAD poised at the last shreds of local support ahead of Canada’s latest CPI print this afternoon. An extension of the sell-off potentially opens up considerable open space on the chart toward 1.2500 or lower.
NZD – the kiwi pressing a bit stronger against the Aussie even as rate spreads extend in the latter’s favour – this has us scratching our head a bit and with limited expectations for NZD outperformance even if the pair breaks below the 1.0850-00 area. The RBNZ set to meet next Thursday, just a few hours after the US Fed.
SEK – the strong Swedish krona is one of the better trends going at the moment as EURSEK nears the first major support levels in the 10.25-20 area, though there may be potential for further extension toward 10.00-10 if the mood in risk appetite remains positive.
NOK – as noted above, we’d be surprised, given the NOK supportive backdrop, to see NOK much weaker here versus the EUR despite the Norges Bank’s lack of hawkish guidance – 9.60-65 is the pivot zone that proves that point one way or another.
Upcoming Economic Calendar Highlights (all times GMT)
• 1230 – Canada Aug. CPI
• 1345 – US Markit Flash Sep. PMI
USD – the US dollar on its back foot even as the entire US yield curve lifts higher as the new widening of yield spreads doesn’t seem to be a source of strength. The USD could run a bit lower given positioning, but eventually, some yield convergence would seem necessary to see further declines. Hard to see how the Federal Open Market Committee surprises next week unless it is in a dot plot shift higher, and the market seems to be absorbing higher US yields anyway.
EUR – the euro clearing the 1.1725-50 area in the EURUSD chart and having a look at flash Eurozone PMI’s this morning (a brief test above 1.1800 was brushed back after the French survey came in a bit soft, but these may not hold back the euro this morning). There may be room for the EURUSD to run higher into the 1.2000 area assuming the FOMC meeting next week gives no surprises.
JPY – the JPY driver is clear, but the action may prove very treacherous and could end in a climactic reversal, either because yields stop rising or the BoJ offers hints on policy at some point. Consider the ugly place that the Bank of Japan finds itself in as outlined in this Bloomberg piece.
GBP – sterling headline risk in constant evidence here as the Brexit negotiations are stalled hopelessly on the Irish border issue and sterling has backed down sharply after surging again yesterday on strong Retail Sales data. Next weekend sees the Tory party conference, another key test of the political temperature.
CHF – the Swiss franc is sideways, a bit surprising given the backdrop, but we did have a slight widening of Italy-core spreads as the FSM’s leadership is not happy with the amount of funding in budget proposals for issues it champions.
AUD – the AUDUSD chart bumping up against the descending channel top – more CNY strength, strengthening risk appetite and commodity strength needed to extend the squeeze – perhaps to the 0.7500 level, though we haven’t changed our position on longer-term negative risks.
CAD – USDCAD poised at the last shreds of local support ahead of Canada’s latest CPI print this afternoon. An extension of the sell-off potentially opens up considerable open space on the chart toward 1.2500 or lower.
NZD – the kiwi pressing a bit stronger against the Aussie even as rate spreads extend in the latter’s favour – this has us scratching our head a bit and with limited expectations for NZD outperformance even if the pair breaks below the 1.0850-00 area. The RBNZ set to meet next Thursday, just a few hours after the US Fed.
SEK – the strong Swedish krona is one of the better trends going at the moment as EURSEK nears the first major support levels in the 10.25-20 area, though there may be potential for further extension toward 10.00-10 if the mood in risk appetite remains positive.
NOK – as noted above, we’d be surprised, given the NOK supportive backdrop, to see NOK much weaker here versus the EUR despite the Norges Bank’s lack of hawkish guidance – 9.60-65 is the pivot zone that proves that point one way or another.
Upcoming Economic Calendar Highlights (all times GMT)
• 1230 – Canada Aug. CPI
• 1345 – US Markit Flash Sep. PMI
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