Yield thrives on market distress

The double whammy of weak risk appetite – not just weak equities, but especially the aggressive rally in global sovereign bonds, has weighed on JPY crosses, with USDJPY perched just above the recent lows and EURJPY and GBPJPY testing new lows for the cycle overnight.

The global benchmark for risk appetite, the US S&P 500 index, closed right on the important 2800 area technical level and slipped below that level overnight in the futures market. Other measures of risk are showing some strain as well – high yield corporate credit spreads look a mirror image of equities, but EM spreads have risen to new highs relative to the early April extremes. And a few EM currencies are starting to show more notable strain: USDZAR closed at a new local high yesterday, as did USDSGD and late yesterday the USDCLP (the Chilean peso long a proxy for copper prices) took out the significant 700 level – its highest close since early 2016.

On the trade front, a rash of speculative articles, referencing “pointed” rhetoric in the Chinese press, suggest China could look to weaponise rare earth minerals exports to the US in the ongoing trade showdown. It is clear that China is settling in for a showdown, not wanting to appear the weaker hand. Arguably, the Chinese gambit is to weaken the US stance by hoping that a weakening of confidence will either hit the US equity market and weaken Trump’s resolve and/or affect his chances in the 2020 election next November. Either way, it is tough to see a path to an immediate thaw in the relationship.

The EU’s Donald Tusk, strongly backed apparently by other EU political leaders, has signalled an unfriendly stance from the EU side on the prospect of opening up Brexit negotiations. Only the “political declaration” is seen as open for discussion, not May’s deal. Tusk even claimed that the spectacle of Brexit was behind the weaker-than-feared (for pro-EU forces) showing of populists in the EU parliamentary elections. The Brexit situation is as murky as ever.

Today’s economic calendar includes Sweden’s Q1 GDP (expected sub-2.0% YoY), Germany’s Unemployment Rate and Change (when are the auto industry woes going to see a broader uptick in job losses?), and the Bank of Canada meeting, where we see a somewhat higher risk of a dovish tilt to the guidance. It’s a difficult call, but given the long string of falling growth data out of Canada and risks from the US-China trade showdown, Poloz and company might err on the side of caution. CAD bulls will point to Citi’s economic surprise index strongly outperformed expectations this year. 

Chart: USDCAD

Clear overhead resistance line in USDCAD ahead of today’s Bank of Canada decision – will Governor Poloz and company fall in line with the global (ex Norway) tilt to easier policy guidance? Today’s decision comes with USDCAD implied volatility near 5% for 1-month – believe it or not well above the Jun 2014 record low of 4%.