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.
Upcoming Economic Calendar Highlights (all times GMT)
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
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