Head of FX Strategy
Summary: German data over the next two days likely to show Germany tilting into a recession. Globally, the negative spiral in global yields continues to drive strength in traditional safe havens.
Trading interest
Our focus on the risk appetite bounce having reached critical levels coming into this week was underlined by the price action yesterday, with the fresh sell-off in risk assets making the recent highs a firmer line in the sand.
Italian Lega Party leader Salvini is still waiting for the confidence vote he is hoping will topple the current government – Italy’s Senate will set the date later today and this will in turn put at least a modest spike in forward options volatility around that date.
German data today (ZEW Survey for August) and tomorrow (GDP for Q2) are likely to show the escalating risk that Germany is tilting into a recession. The broader economy has been held up by a modest consumption and housing boom as years of negative rates finally swung the German real estate sector into gear. The Germany export engine and manufacturing sector are in dire recession, meanwhile.
The US yield curve continues to flatten aggressively – yesterday saw the 10-2 spread down to a mere six basis points, suggesting that the Fed has yet to bring sufficient easing to the table to steepen the curve. It’s remarkable how different the yield curve behavior is this time around relative to the 2006-07 experience. Back then, by the time the Fed actually began chopping rates in September of 2007, the yield curve was steepening aggressively (from negative earlier in the year to over 50 basis points by the first cut). Now we have a Fed that has reversed QT and cut rates and yet the flattening continues. The US 30-year benchmark, in fact, looks set to post an all time low in coming sessions, now less than two basis points above the 2016 level of 2.09%
CNY relatively stable, but the fix continues to come in slightly lower every day for USDCNY, today at 7.03. The situation in Hong Kong is becoming perhaps a greater focus for the knock-on geopolitical risks if the crackdown on protests is escalated to a new level. US Congress members were out making noise yesterday, while President Trump has been largely quiet on the issue.
Chart: USDJPY
USDJPY posted minor new lows yesterday, but could be set to accelerate lower here if we see a more profound sell-off in risk assets and new lows for the cycle in the major sovereign long bonds. Technically, the last area of notional support around 104.50-105.00.
The G-10 rundown
USD – the Fed has its work cut out for it as the July 31 FOMC meeting risks increasingly looking like a policy mistake that will take a major hint from Fed officials or even an unscheduled rate cut to turn back.
EUR – EURJPY the favourite way to express downside risks on EU existential concerns linked to Italy and even more so, the risk of Germany slipping into recession.
JPY – JPY back on the bid this morning, with USDJPY pressing down toward the last area of support in the 105.00-104.50 zone. A deepening risk off combined with the negative spiral in bond yields could set a bit more determined JPY strength in motion here toward 100.00 in USDJPY
GBP – yesterday, the news that some in Parliament are increasing their efforts to avoid a No Deal Brexit steered EURGBP back lower after a break to a (non-flash-crash) post-Brexit high. But few signs that this is enough to sustain confidence.
CHF – the weekly SNB sight deposit data showing weekly gains again yesterday, some CHF 3 billion for the last week, as the SNB has been leaning against this latest move in CHF strength. More downside risk for EURCHF as long as spiral lower in rates continues, with further CHF strength risk from Brexit and Italy stories.
AUD – sentiment is very negative and positioning somewhat crowded, so the path lower for the Aussie is a difficult one – next steps are tonight’s Q2 wage data and the employment data early Thursday
CAD – USDCAD rally has stalled in an important pivot zone up to 1.3300+ with upside swing risks on further deterioration in the risk outlook and from weaker oil prices.
NZD – No follow-on momentum yet after the RBNZ got ahead of market expectations last week – need further weakness very soon to prove that this was enough. 1.0500+ area in AUDNZD in focus as 200-day moving average in focus there.
SEK – July Swedish CPI up tomorrow, but unlikely to serve as a major catalyst as currency weakness is the only driver of a possible upside surprise, which is still expected lower than Germany’s current 1.7% headline rate.
NOK – EURNOK trading nervously around 10.00 ahead of Thursday Norges Bank meeting. The NOK at historic weak levels, but smaller currencies not in favour here as long as safe havens and Gold/silver are rallying and market justifiably fears the Norges Bank will climb down from its normalization policy, especially now that oil prices are perched near the lows for the year.
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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.
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