Macro: Sandcastle economics
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FX Update: Move in yields – and FX – may be overdone here
John Hardy
Head of FX Strategy
Summary: The global bond rally looks remarkably stretched. Today we discuss the risk of a reversal and what this will for currencies, where some exchange rate moves have correlated closely with recent bond market moves.
Trading interest
- Maintaining long AUDNZD with stops below 1.0420 for 1.0625 and eventually 1.0700
- Maintaining long EURUSD call options (now unhedged) and/or adding spot for 1.1400 initially with stops sub-1.1120
Global bonds’ blowout rally
The blowout rally in global long bonds may have reached at least a temporary climax after yesterday’s aggressive extension and partial reversal. This could have important implications across major and minor currencies as well, especially the Japanese yen and Swiss franc, as these two have correlated rather closely with the direction in the bond market over the last several months.
Yesterday I tweeted the chart below, showing the price of a 2048 German zero-coupon sovereign bond, which was up over 35% YTD as of yesterday, while the S&P, having posted a spike low into year end and rebounding for much of this year despite the recent wobble, is up only about 16%. The headlines scream that so-and-so many trillion USD in global bonds are showing negative yields – but aren’t thinking about the spectacular returns on the underlying price that is likely driving much of the performance chasing. One twitter user noted that the 100-year Austrian sovereign had rallied 60%, to which I replied that if anyone has issued a zero-coupon perpetual bond, it should have rallied by infinity by now. By the way, the madness of all of this – and specifically the mathematics of these examples is the primary reason that gold and silver are so bid. A key question short term for the metals is whether they will remain correlated here with bond prices or also suffer a bit of a correction in the event of a reversal. Don’t know about the latter, but with a German 30-year sovereign yield moving having gone negative in recent days, the high momentum days are likely over.
Chart: German 2048 zero coupon bond price versus S&P 500
Yesterday saw a fairly large intraday reversal in this recent spike in bond prices and at some point, a parabolic move like this has to reverse. If it does, I would suggest that some of the largest moves in response to such a reversal might be found within the G10 currencies, where the moves have been extreme and on a scale rarely seen before. A brief rundown of the current status of the G10 currencies if bonds suffer a climax reversal here or soon:
- Overdone strength: CHF and JPY
- Overdone weakness: NOK, SEK, AUD, CAD
- Somewhere in between: EUR and USD
We hesitate to add NZD to the “overdone weakness” category due to the recent dovish blast from the RBNZ’s Orr and company, as the RBNZ is a bit fresh in getting more determinedly on the devaluation warpath. GBP is in its own category as well as the weakness there is down to a unique driver, Brexit.
In EM, the curious TRY rally through all of this begs the question of whether TRY strength was a product of manipulation or a symptom of the consensus that TRY is the most troubled of the more liquid EM’s and it has been a no-brainer to short the currency versus the rest of the EM space, which has mostly struggled badly recently (RUB, MXN, ZAR, etc.)
Chart: SEKJPY monthly
Note that SEKJPY is approaching all-time lows as it slips towards the 11.00 level. This is one of the many trades within the G10 that has pushed to remarkable extremes – especially the CHF- and JPY- crosses. This is not to say that a reversal will happen now, but the long-term present starkly asymmetric risk-reward and any immediate reversal in the bond rally could see a strong reversal in these trades as well.
Chart: EURUSD
Not as stretched within the G10 space as other pairs, but still interesting, EURUSD is trying to turn higher here on the logic that the Fed will be forced to ZIPR and QE again while the ECB has less policy room to work with. The pair has managed a relatively shallow consolidation over the last few trading days. We will continue to focus higher as long as the pair stays north of 1.1100, though ideally the consolidation lows back to 1.1150 are already in.
Given the recent spike in bond and equity markets since the July 31 FOMC meeting and the tit-for-tat of Trump tariffs and China allowing USDCNY to poke above 7.00, risk sentiment and the status and sustainability of all of these recent moves is the chief driver here. Cross market correlations are a particular danger that can enhance both losses and profits in a traders’ portfolio of positions. In other words, be careful out there – this feels like a very correlated, headline-prone, nervous market.
Upcoming Economic Calendar Highlights (all times GMT)
- 0800 – Norway Norges Bank Q2 Lending Survey
- 1230 – Canada Jun. New Housing Price Index
- 1230 – US Weekly Initial Jobless Claims
- 2330 – Australia RBA’s Lowe in semi-annual testimony to Parliamentary committee.
- 2350 – Japan Q2 GDP estimate
- 0130 – China Jul. CPI
- 0130 – Australia RBA Statement on Monetary Policy
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