Head of FX Strategy
Summary: The sharp rally in US treasuries and fall in yields in recent sessions has brought some profound relief to the lowest yielding currencies, from the euro to the most negative yielding of them all, the Swiss franc. The move could yet deepen further, but far too early to call a change of trend. Elsewhere, India and Russia are worth mention in the EM space.
FX Trading focus: US Treasury rally prompts sharp moves in low-yielders
The comeback in US treasuries, already rather noteworthy in light of recent very strong US macro data, extended sharply yesterday, taking US yields lower all along the yield curve and clearly a driver of the lately very yield-sensitive “lowest yielders” among G10 currencies. Indeed, the lower the 10-year yield, in the case of EUR, JPY and CHF, the better the return in April, as can be seen in the scatter plot below, where the general pattern has been that the highest yielders as of the end of the March have fared more or less the worst while the lowest yielders have clearly done the best. Note that for the calculations below, for the 10-year “EUR yield”, I used the average of the German Bund, French 10yr OAT and Italy 10yr BTP yield.
Graphic: 10-year yield as of March 31 against return vs. USD since then
So what now? First, while the JPY has consolidated back to the strong side, I am somewhat surprised that it has not appreciated more – this may be down to still quite calm EM markets (carry trades, etc, with exceptions noted below) and solid risk sentiment in general. Arguably, the correction in yields can deepen a bit – perhaps taking the US 10-year benchmark back toward the 1.50% level, and thus provide a further nominal further boost for the lowest yielders, but I have a hard time seeing why yields should drop beyond that level unless we are in some unforeseen new bout of risk aversion, so the market will likely soon have to move on to other themes. As well, one of the indicators I like to watch for yield sensitivity is gold, and there, the consolidation was sharp initially but has failed to do much over the last couple of sessions, a bit of a head-scratcher, as the recent past would have seen far peppier gold upside on a chunky drop in US yields.
A key point from here is whether a firmer US treasury market is signaling an agreement with the Fed outlook on inflation and growth, i.e., that we are set for a brief surge of inflationary over-heating, but that the anticipation of a lack of fresh fiscal impulses of notable size beyond this quarter will see the effects wane rapidly – a kind of “stop-start” risk pattern that has been visible in some of this data series. If this is the narrative that begins to win out, a bit of consolidation across the commodity space and even into risk sentiment could mean we continue to see outperformance of the low yielders and the US dollar secondarily, while the traditionally more pro-cyclical currencies come in for some rough sledding.
Note that the FOMC minutes and a bevy of Fed speakers are on tap for later today.
Chart: USDCHF
A USDCHF correction has set in, one with somewhat greater amplitude relative to the recent rise than the correction we are seeing in the US treasury market, though the latter is clearly the driver. But the late rally has altered the structure of the chart, neutralizing the former down-move, so whether here, or in USDJPY, we’ll be looking out for support to come in sooner rather than later. With a correction back to 1.50% for the US 10-year benchmark, the USDCHF pair may move back to something like 0.9200 or perhaps even 0.9100, the 200-day moving average.
EM divergences – TRY, INR, RUB, ZAR
In aggregate, things are fairly quiet on the EM front, but there are a few stories worth noting here. The Turkish lira exchange rate continues to triangulate while the forward implied yields have calmed considerably, rewarding those who took the plunge and bet against immediate chaos by selling USDTRY forwards. And the credit spreads on Turkish debt have also tightened a bit less than half way back to where they were before Erdogan’s shock shuffle of the central bank leadership. TRY is still a risky proposition – have to watch the next signals from the new central bank chief – especially on next Thursday’s rate decision.
The Ruble is very weak relative to crude oil and the tightening message from the Russian central bank and has to be an expression of a geopolitical risk discount that is growing. Rumblings of the situation in Ukraine and the overhanging concerns on sanctions could continue to weigh until something sets the situation in a different direction.
The Indian rupee, INR, is in focus after the central bank there moved forward with a modest QE programme, with plans to purchase a trillion rupees (south of $15 billion) in Indian government bonds. The INR was down about 1.5% on the story as of this writing. India is experiencing a vicious new rise in Covid cases, though hopefully the latest jump in the pace of vaccinations can accelerate further in coming days and weeks.
The South African rand is back close to the cycle highs versus the US dollar, held in part aloft by calm seas in EM credit, the stories above notwithstanding, but also by a strong platinum price, which all ZAR traders should track as an important input.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
