Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Risk aversion sees odd and garbled FX reaction
John J. Hardy
Chief Macro Strategist
Summary: The US dollar was broadly weaker coming into today, with EM currencies at least partially – and oddly – immune to a very weak risk appetite backdrop.
Also a head-scratcher, normally yield- and risk-sensitive yen traders have largely sat on their hands even as US treasury yields have dropped during this latest bout of weak risk appetite. These conditions can hardly persist.
Stitching together a narrative for this FX market is rather tough as intermarket correlations are not what they used to be: here we have a very ugly sell-off in the major developed economies’ equity markets and US treasuries heavily bid and yet the Japanese yen is merely a percent and a half off recent highs.
Elsewhere, the weight of risk appetite weakness yesterday only saw marginal weakness in the G10 smalls one would normally expect in these circumstances, but NZDUSD still looks bid and is toying with the 200-day moving average from the below. And emerging market currencies are mixed at worst and several are very strong despite the ugly backdrop, including a South African rand that is near local highs versus the US dollar even as the country’s credit spreads on USD-denominated bonds have worsened materially over the last couple of weeks.
The only narrative I might offer to explain what is going on is that the world has generally been long of US dollars on the argument that the aggressive Fed will continue to raise rates and tighten global liquidity. But now, the latest weakness in key indicators and risk appetite and some of the Fed speakers’ rhetoric, together possibly with the hope that China will ride in to save the day and/or that the Xi and Trump will at least announce a ceasefire at the G20 next week, has the market hoping that the Fed will ease up. That makes the next two key event risks the Xi-Trump summit at the G20 and the December 19 Federal Open Market Committee meeting.
A significant contributor to the weakness in the USD yesterday was the US NAHB survey of home builder activity, one of the more leading indicators for the US housing market, which registered a stunning 8 point drop to 60 for October. This points to a very low ceiling for the most interest rate sensitive of US economic sectors – the mortgage markets. It also adds to the potential reactivity to today’s Oct. US Housing Starts and Building Permits numbers, which have gone sideways to slightly lower in recent months.
Chart: AUDJPY
AUDJPY is the classic risk-on, risk-off G7 FX pair, and yet has only barely managed to register a correction despite the weak conditions of the last session. This may be down to conflicting signals – on the one hand, the market is hopeful that China can lead the world out of its current funk and that the US and China are set to at least announce a trade war ceasefire at the G20 summit with Xi and Trump in attendance. On the other hand, the JPY traditionally powers higher under current market conditions – something has to give either way in coming weeks.
The G-10 rundown
USD – the US dollar is on its back foot as US yields drop and the market waits for the Fed to blink. The key question for me is whether the USD can continue to show across-the-board weakness if risk deleveraging reaches white-hot levels again.
EUR – the EURUSD rally is now staring down the big round 1.1500 level, with the rise largely tracking the drop in yield spreads as US yields fall. To continue to find fuel from this source, the US 10-year benchmark will have to have a look below the pivotal 3.00% level.
JPY – would have expected a much lower USDJPY already, given the US 10-year yield drop and weak risk appetite, but resilient EM sticks out and the JPY may not perform until or unless weak risk appetite is an across-the-board affair.
GBP – sterling is finding minor relief as it appears that Theresa May will survive the latest challenge to her leadership – but beyond that, we have little to go on for what the Brexit process will look like from here. Note that Bank of England speakers are out today and likely to offer reasonably stiff defense of the pound from a rate policy angle.
CHF – Italian yield spreads making EURCHF uncomfortable again – local range lows just below 1.1350 and could give way on another headline or two of the wrong stripe and aggravation of EU-Italy spreads.
AUD – the Aussie’s ambitions pushed back lower overnight as the backdrop isn’t very supportive. From these levels, significant two-way risks into whatever emerges from G20.
CAD – USDCAD looking heavy now on the reversal back below 1.3200. A Bank of Canada speaker out late today could add colour.
NZD – the kiwi finding strong bids – and 1.0600 is a big trend-line in AUDNZD, while NZDUSD is staring down its 200-day moving average just below 0.6900. Looking overdone soon, but AUDNZD techs suggest more downside potential if the trend-line gives way.
SEK – the krona not comfortable with the weak sentiment on Europe and EURSEK has poked around at the 200-day moving average, so far surviving.
NOK – NOK is getting the worst of it as NOKSEK runs away to the downside and still weak oil weighs. EURNOK running out of upside range as 9.75 approaches.
Upcoming Economic Data Highlights (all times GMT)
1000 – UK BoE’s Carney, others to testify
1100 – UK Nov. CBI Trends Total Orders / Prices
1330 – US Oct Housing Starts and Building Permits
1500 – ECB/Bundesbank’s Weidmann to speak
1630 – ECB’s Nouy to speak
1745 – Canada BoC’s Wilkins to speak
USD – the US dollar is on its back foot as US yields drop and the market waits for the Fed to blink. The key question for me is whether the USD can continue to show across-the-board weakness if risk deleveraging reaches white-hot levels again.
EUR – the EURUSD rally is now staring down the big round 1.1500 level, with the rise largely tracking the drop in yield spreads as US yields fall. To continue to find fuel from this source, the US 10-year benchmark will have to have a look below the pivotal 3.00% level.
JPY – would have expected a much lower USDJPY already, given the US 10-year yield drop and weak risk appetite, but resilient EM sticks out and the JPY may not perform until or unless weak risk appetite is an across-the-board affair.
GBP – sterling is finding minor relief as it appears that Theresa May will survive the latest challenge to her leadership – but beyond that, we have little to go on for what the Brexit process will look like from here. Note that Bank of England speakers are out today and likely to offer reasonably stiff defense of the pound from a rate policy angle.
CHF – Italian yield spreads making EURCHF uncomfortable again – local range lows just below 1.1350 and could give way on another headline or two of the wrong stripe and aggravation of EU-Italy spreads.
AUD – the Aussie’s ambitions pushed back lower overnight as the backdrop isn’t very supportive. From these levels, significant two-way risks into whatever emerges from G20.
CAD – USDCAD looking heavy now on the reversal back below 1.3200. A Bank of Canada speaker out late today could add colour.
NZD – the kiwi finding strong bids – and 1.0600 is a big trend-line in AUDNZD, while NZDUSD is staring down its 200-day moving average just below 0.6900. Looking overdone soon, but AUDNZD techs suggest more downside potential if the trend-line gives way.
SEK – the krona not comfortable with the weak sentiment on Europe and EURSEK has poked around at the 200-day moving average, so far surviving.
NOK – NOK is getting the worst of it as NOKSEK runs away to the downside and still weak oil weighs. EURNOK running out of upside range as 9.75 approaches.
Upcoming Economic Data Highlights (all times GMT)
1000 – UK BoE’s Carney, others to testify
1100 – UK Nov. CBI Trends Total Orders / Prices
1330 – US Oct Housing Starts and Building Permits
1500 – ECB/Bundesbank’s Weidmann to speak
1630 – ECB’s Nouy to speak
1745 – Canada BoC’s Wilkins to speak
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