Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Markets at a key inflection point
John J. Hardy
Chief Macro Strategist
Summary: We are keeping an eye on JPY as markets, as well as risk sentiment more broadly, have potentially arrived at a crucial crossroads.
Markets look highly correlated and potentially poised at an important inflection point here – whether major equity indices, oil, or JPY crosses. We focus on the last of these for potential trading implications in currencies if we are set to roll over into a fresh bout of risk-off behaviour as major equities have reached the “either-or” resistance. Given the firmer US dollar, any fresh consolidation of risk appetite is likely to deliver a bigger blow to smaller DM and EM currencies versus the JPY than to USDJPY.
In the UK, Prime Minister May has survived the confidence vote and sterling somehow managed to piece together a bit more strength despite no agreement on what comes next. May will have to declare a Plan B by Monday, and Labour has rebuffed her overtures for cross-party talks that would see the UK presenting a more united negotiating front to the EU.
Two things to note here: first, the very issue of Brexit is not a partisan issue and cuts straight across both the Labour and Conservative parties, only adding to the inability of the UK to formulate a coherent plan. Second, the default option if nothing is done is a hard exit on March 29.
We get the news this morning that Chinese Vice Premier Liu will indeed visit the US later this month for further talks – one assumes that this important step means that the US and China are nearing terms on a deal. Still, the risk is that whatever trade terms are agreed, it will prove mere window dressing to avoid immediate economic weakness that doesn’t counter the inertia of a deepening confrontation between the two superpowers.
Chart: EURJPY
Although JPY crosses like AUDJPY will likely trade with the most beta to risk appetite, we like to focus on the risk of EURJPY downside on the combination of rising concern for the EU’s economic outlook and what are likely to prove rising concerns on EU existential risks with a bit of negative Brexit outcome optionality built in, while the JPY should outperform in the even we are in for a bit more rough sailing in risk appetite again.
In the UK, Prime Minister May has survived the confidence vote and sterling somehow managed to piece together a bit more strength despite no agreement on what comes next. May will have to declare a Plan B by Monday, and Labour has rebuffed her overtures for cross-party talks that would see the UK presenting a more united negotiating front to the EU.
Two things to note here: first, the very issue of Brexit is not a partisan issue and cuts straight across both the Labour and Conservative parties, only adding to the inability of the UK to formulate a coherent plan. Second, the default option if nothing is done is a hard exit on March 29.
We get the news this morning that Chinese Vice Premier Liu will indeed visit the US later this month for further talks – one assumes that this important step means that the US and China are nearing terms on a deal. Still, the risk is that whatever trade terms are agreed, it will prove mere window dressing to avoid immediate economic weakness that doesn’t counter the inertia of a deepening confrontation between the two superpowers.
Chart: EURJPY
Although JPY crosses like AUDJPY will likely trade with the most beta to risk appetite, we like to focus on the risk of EURJPY downside on the combination of rising concern for the EU’s economic outlook and what are likely to prove rising concerns on EU existential risks with a bit of negative Brexit outcome optionality built in, while the JPY should outperform in the even we are in for a bit more rough sailing in risk appetite again.
The G-10 rundown
USD – the US dollar staying firm despite the government shutdown and could maintain an even keel if risk appetite has peaked for now, save versus the JPY, which outperformed every other major during the worst of the December downdraft.
EUR – the euro struggling for inspiration in either direction, effectively neutral now that EURUSD has shifted back to mid-range after rejecting the upside break. 1.1300 and 1.1550 the next trigger levels for interest.
JPY – a proxy for risk appetite here, though an interesting twist on the situation that could mute JPY upside potential would be weak risk appetite driven by the concern that the market has over-interpreted the Fed’s dovish intentions, sending short US rates back higher.
GBP – the weakest RICS House Price Balance reading for the cycle since 2012 overnight is a worry for UK consumer sentiment, as are the next steps for Brexit and the risk that the market is too complacent on the risk for either a no deal or elections.
CHF – latest rally in EURCHF at odds with weak risk sentiment, but we won’t try to build a narrative here, other than that EURCHF does not correlate as strongly as it used to with broad risk appetite and USDCHF is poking back higher.
AUD – the Aussie merely easing away from its recent strength rather than decidedly weak. AUD likely to show sensitivity to risk off, but supported at the margin as long as USDCNY remains below 6.80.
CAD – USDCAD likely correlated with risk appetite and oil prices here, with low beta to other USD pairs unless we get a shocker with tomorrow’s CPI release.
NZD – we have noted the chunky drop at the front end of the NZ yield curve as the market prices mounting odds of an eventual RBNZ rate cut, and AUDNZD is taking note – a close above 1.0620 today would represent a 19-day breakout that we noted in yesterday’s FX Breakout Monitor and could mean a rally into 1.0800-50 next.
SEK – EURSEK not only not breaking lower, but poking at 10.29+ area resistance, a further disappointment for bears and risk off could see risk toward 10.35 and higher.
NOK – EURNOK move below the 9.75 level so far not bearing fruit for the NOK bulls, and the risks for NOK are to the downside if risk appetite and oil prices (lately very highly correlated) roll over.
Upcoming Economic Calendar Highlights (all times GMT)
• 1000 – Euro zone Dec. Final CPI
• 1100 – ECB’s Lautenschlaeger to Speak
• South Africa Reserve Bank Announcement (no time indicated)
• 1330 – US Jan. Philadelphia Fed
• 1330 – US Weekly Initial Jobless Claims
• 1545 – US Fed’s Quarles to Speak
• 2330 – Japan Dec. CPI
USD – the US dollar staying firm despite the government shutdown and could maintain an even keel if risk appetite has peaked for now, save versus the JPY, which outperformed every other major during the worst of the December downdraft.
EUR – the euro struggling for inspiration in either direction, effectively neutral now that EURUSD has shifted back to mid-range after rejecting the upside break. 1.1300 and 1.1550 the next trigger levels for interest.
JPY – a proxy for risk appetite here, though an interesting twist on the situation that could mute JPY upside potential would be weak risk appetite driven by the concern that the market has over-interpreted the Fed’s dovish intentions, sending short US rates back higher.
GBP – the weakest RICS House Price Balance reading for the cycle since 2012 overnight is a worry for UK consumer sentiment, as are the next steps for Brexit and the risk that the market is too complacent on the risk for either a no deal or elections.
CHF – latest rally in EURCHF at odds with weak risk sentiment, but we won’t try to build a narrative here, other than that EURCHF does not correlate as strongly as it used to with broad risk appetite and USDCHF is poking back higher.
AUD – the Aussie merely easing away from its recent strength rather than decidedly weak. AUD likely to show sensitivity to risk off, but supported at the margin as long as USDCNY remains below 6.80.
CAD – USDCAD likely correlated with risk appetite and oil prices here, with low beta to other USD pairs unless we get a shocker with tomorrow’s CPI release.
NZD – we have noted the chunky drop at the front end of the NZ yield curve as the market prices mounting odds of an eventual RBNZ rate cut, and AUDNZD is taking note – a close above 1.0620 today would represent a 19-day breakout that we noted in yesterday’s FX Breakout Monitor and could mean a rally into 1.0800-50 next.
SEK – EURSEK not only not breaking lower, but poking at 10.29+ area resistance, a further disappointment for bears and risk off could see risk toward 10.35 and higher.
NOK – EURNOK move below the 9.75 level so far not bearing fruit for the NOK bulls, and the risks for NOK are to the downside if risk appetite and oil prices (lately very highly correlated) roll over.
Upcoming Economic Calendar Highlights (all times GMT)
• 1000 – Euro zone Dec. Final CPI
• 1100 – ECB’s Lautenschlaeger to Speak
• South Africa Reserve Bank Announcement (no time indicated)
• 1330 – US Jan. Philadelphia Fed
• 1330 – US Weekly Initial Jobless Claims
• 1545 – US Fed’s Quarles to Speak
• 2330 – Japan Dec. CPI
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