FX Update: Yield curve inversion worries? Steepening may not help.

Forex 7 minutes to read

John Hardy

Head of FX Strategy, Saxo Bank Group

Summary:  The US yield curve has officially inverted and to get ahead of the curve, the Fed may have to cut rates by fifty basis points, with the chatter increasingly that they could do so before the next regularly scheduled meeting on September 18.


Trading interest

  • Maintaining long AUDNZD with stops below 1.0450 now for 1.0625 and eventually 1.0700
  • Abandoning short AUDUSD half position after interest in selling above 0.6800.
  • Shorting EURJPY for 112.00 as long as remains below 119.50

The sharp rally in risk assets inspired by Trump’s tariff schedule delay on Tuesday faded quickly and then some yesterday as the Chinese response was hardly promising and further Trump tweets take the risky approach of linking trade deal progress with Hong Kong – likely a no-go area for China. Major equity indices suffered large losses in the violent momentum shift from the prior day’s squeeze.  A bit spooky, to say the least, that the mood can shift so viciously.

The rally in long duration continued yesterday, and the long-term obsession with the flattening US yield curve may begin to ease now that we have “achieved” an official inversion for the 2-10 portion of the US yield curve. The long 30-year US T-bond yesterday posted a new record low just below 2.00%. The narrative in the headlines suggests the yield curve inversion was the chief driver of the carnage in equity markets yesterday. But let’s remember that in the past, most market pain usually comes later, when policymakers are scrambling to ease quickly enough to provide stimulus and actually steepen the yield curve. Cue the latest chatter that the Fed will now be forced to cut rates before the regularly scheduled September 18 FOMC meeting to get ahead of galloping concerns. This is indeed a strong possibility and the Fed will have to move by fifty basis points, whether between meetings or in September, to even have a chance to slow the yield curve inversion. (50 basis point chop priced at nearly 40% probability for the Sep. FOMC meeting currently).

German data yesterday confirmed the weakness in the German economy as the headline Q2 GDP number came in at the expected -0.1% QoQ, although other versions of the number, like the “work-day adjusted” tally was actually a fairly strong beat at +0.4% vs. +0.1%. But no matter, German yields plunged lower still and the 30-year German sovereign stands at a stunning -21 basis points this morning. EURUSD retreated farther below 1.1200 as well to as low as 1.1135.

The CNY fix came in a hair weaker again today, providing little new energy in an otherwise nervous market.

Chart: USDCAD
The Canadian dollar has held relatively firmly until the last couple of weeks as weak oil prices have begun to apply downside pressure on top of wobbly risk appetite. Still, the 2-year US-Canada rate has moved into negative territory as the Fed is now seen as cutting more aggressively than the Bank of Canada over the next year. The market pricing just under 50 basis points of rate cuts through next June from the Bank of Canada, an outlook that will be tough to square with a weakening global growth environment. USDCAD zipped back toward the 1.3300+ resistance, the pivotal area that is the last pivot zone ahead of the 1.3500+ prior highs. Any further plunge in risk appetite and  oil prices here likely to put pressure on the market’s views of Bank of Canada’s likely policy path and on the currency itself.

Source: Saxo Bank

The G-10 rundown

USD – strength remains relatively broad as USD safe haven certainly retained its credibility yesterday. Trump’s trashing of the Fed seems to offer less pressure than it has before. US Retail Sales today – an indicator that has had a run of positive prints over the last four months.

EUR – concerns that the EU economy is slipping and that a fiscal response will be weak and late seeing the euro fading lower versus the USD.

JPY – strength in long yields driving yen strength here, though still somewhat underperforming its normal potential, given the magnitude of yesterday’s downdraft in risk.

GBP – strong jobs data yesterday takes the edge off immediate economic concerns while the market still frets hard Brexit risks.

CHF – tracking the ups and downs of risk off here with no fresh pressure from Brexit woes or EU existential worries.  USDCHF a bit interesting as it has put up a fight in not allowing the 0.9700 area to fall.

AUD – a solid jobs report overnight keeps the pressure off the RBA to cut rates sooner rather than later, and allows a bit of AUD resilience in the crosses. AUD downside versus safe havens making little progress despite ugly risk off yesterday – a bit of a warning sign?

CAD – under pressure from the latest risk deleveraging and weak oil prices – and Bank of Canada won’t want to be the odd one out if Fed forced to cut aggressively – watching the recent highs in USDCAD with interest for possible quick spillover toward 1.3500+ on a break.

NZD – AUDNZD trying desperately again to make itself interesting after the solid Australia jobs report overnight – needs to stick higher here above 200-day moving average to maintain immediate upside focus.

SEK – SEK trading passively to risk appetite, with yesterday’s risk off putting an emphatic local low on the EURSEK chart.

NOK – Norges Bank up this morning, where we are looking for a downshift in the Norges Bank’s guidance on further rate hikes – too out of touch with what is going on in the rest of the world. This could drive new all-time highs for EURNOK if we see another round of risk-off and weaker crude oil prices.

Upcoming Economic Calendar Highlights (all times GMT)

  • 0800 – Norway Norges Bank Rate Announcement
  • 0830 – UK Jul. Retail Sales
  • 1230 – US Aug. Empire Manufacturing
  • 1230 – US Q2 Nonfarm Productivity and Unit Labor Costs
  • 1230 – US Philadelphia Fed Survey
  • 1230 – US Jul. Retail Sales
  • 1230 – US Weekly Initial Jobless Claims
  • 1315 – US Jul. Industrial Production and Capacity Utilization
  • 1400 – US Aug. NAHB Housing Market Index
  • 1800 – Mexico Central Bank Interest Rate

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