Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Yen rises, global risk appetite weakens on latest Trump move
John J. Hardy
Chief Macro Strategist
Markets have opened the week on a sour note on Trump’s latest move to limit Chinese investment in US companies in industries thought linked to national security, from aerospace to robotics. The previous rounds of threatened tariffs are set to go into effect on July 1. As well, China cut its bank reserve requirements by some $100 billion to offset some of the pressure from deleveraging in the shadow banking sector and purportedly to support smaller businesses.
The contrast of China’s easing with the US Federal Reserve’s tightening is glaring and China has allowed the yuan to weaken more rapidly than at any point since last September (that fall in the yuan only came after a rather brutal episode of yuan strength). Speculation is mounting on whether China will mobilise the exchange rate as a weapon in the trade showdown with the US, although this would present risks to its hopes to promote the CNY’s use in trade.
Elsewhere, Turkey’s election saw a sufficiently strong result in favor of President Erdogan that he can avoid a second run-off round. The lira was stronger in response, though I am struggling to understand why outside of a sell-the-rumour, buy-the-fact response to this major event risk, as Erdogan will need to reassure foreign capital that he will not interfere with necessary central bank policy medicine or take other steps, like unaffordable fiscal stimulus. Credit spreads improved across EM’s late last week, also providing a more supportive backdrop for TRY.
After this election, Erdogan has more leeway to control the fate of the country’s policy now as sweeping new powers for the executive now go into effect. As a Bloomberg headline trumpets, “Erdogan election triumph takes Turkey into the era of one-man rule”.
In Europe, an emergency mini-summit over the weekend shows the level of discord over how to deal with migrants into the Eurozone. Italy’s new government presented a 10-point plan to deal with migration and off-load the pressure on Italy. At issue is whether asylum seekers must stay in the country where they arrive and their cases are being processed. Countries on the Mediterranean, especially Italy and Greece, who have dealt with the heaviest inflow of migrants, feel that arriving at its shores is the same as arriving in the EU. There was no concrete outcome to the talks and this week’s EU Summit is unlikely to produce any deepening agreement either. All of this comes as Merkel must deal with a deadline from her coalition partner CSU and its leader Horst Seehofer, on whether to accept entry by migrants being processed by other EU countries at its southern border.
Chart: EURJPY
EURJPY looking heavy again after multiple recent attempts to punch down through the 127.00 area. The EU potential combination here of a phase of aggravated political uncertainty in the EU and weak risk appetite globally could favour further downside for the pair into the 125 level that was tested during the large flare-up in EU spreads after the formation of the populist Italian government.
The G-10 rundown
USD – the greenback fairly firm as risk aversion favours its bottomless liquidity even as the market lowers Fed rate hike expectations. It’s still too early to tell if the USD staged a reversal late last week – it wouldn’t take much. USD shorts may limit their focus to USDJPY for now, while favoured USD longs if the latest trading themes extend are via AUDUSD shorts and USDCAD longs.
EUR – hard to like the euro in these circumstances and this week’s EU council meeting likely to continue to show how far the union remains from being a proper “union”. As indicated above, the euro may prove most vulnerable here versus the yen. Merkel’s eventual fate is a near-term focus.
JPY – the yen hitting its stride as yields fall and risk appetite weakens globally and there could be more in store this week. USJDPY facing down an important technical level in the form of the Ichimoku daily cloud top near 109.50.
GBP – sterling treading water even with last week’s hawkish turn from the BoE. There was supposed to be additional focus on Brexit this week over the EU summit, but the migration situation has taken top billing – EURGBP is in lockdown between 0.8700 and 0.8850.
CHF – EURCHF under pressure and should continue to reflect EU existential pain, with the risk of a bit of a crescendo linked to the German political situation.
AUD – the Aussies should remain vulnerable in this environment and isn’t it rather sobering that China’s new stimulus effort hasn’t elicited a more enthusiastic response?
CAD – a weak CPI print on Friday (2.2% YoY on the headline versus 2.6% expected and two of the three “core” readings were below expectations at 1.9% year-on-year versus 2.1% expected).
NZD – the next event risk for the kiwi is the Reserve Bank of New Zealand meeting this Thursday and whether new governor Orr can surprise the market again after insisting on two-way policy guidance (dovish) at his first meeting.
SEK – risk-off and EU existential worries are not supportive for SEK, and EURSEK is looking above local resistance this morning around 10.35.
NOK – Opec developments last week not supporting the oil price and risk off is no joy for NOK bulls either. A move above 9.50 in EURNOK would further disappoint hopes for a NOK revival.
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