Risk sentiment strong despite trade war, rising yields

Two key developments driving market action at the moment for the major currencies:

Rising bond yields: rising sovereign bond yields around the world are driving a weaker USD and a weaker JPY due to the ability of risk sentiment to rally at the same time. Yes, in many cases the US rate rises are a bit sharper than elsewhere, but the sense of some convergence nonetheless (core EU yields have risen nearly as fast as US yields) is helping other currencies to keep pace with the greenback and even rally sharply. In Japan’s case, the more or less fixed yields out to 10 years mean that the currency absorbs the impact of rate rises elsewhere since JGB’s theoretically can’t. An until the Bank of Japan sends the signal that it will turn yields loose to move of their own accord, and/or until the US Tweeter-in-Chief turns his attention to BoJ policy and JPY weakness as essentially a pillar of Japanese economic policy, the JPY will likely weaken in tact with the rise in yields. Overnight, the Bank of Japan failed to show signs of shifting on policy once again.

Risk-on despite trade war headlines: the ability of markets to put on a risk-on show just as the US and China have announced their most aggressive trade tariff announcements looks like a classic “sell the fact” moment, as risk has rallied across the board despite this latest very aggressive exchange between the US. Everyone is searching for answers on how this can be, and not sure I have much to add to the noise other than agreeing that China’s electing to go with a 5-10% level on its latest round of tariffs rather than 10% across the board suggests a measure of friendliness in its stance. As well, fresh promises not to use CNY devaluation as a policy provided a fillip (which makes sense as China’s external balances show imports rising far more rapidly than exports in recent years and especially the energy import bill would rise perilously if China chose the devaluation route).

Today, look out for the UK CPI up this morning and then how the Brazilian real and other EM currencies react to today’s rate announcement from Brazil’s central bank. Brazil’s currency has been under tremendous pressure, but the central bank has failed to signal any intent to hike rates. The first round of the country's chaotic presidential election is up on October 7.

Chart: AUDUSD

The Aussie is working higher on the ebullience in Asian markets despite the latest exchange of tariff threats from the US. China’s avowal to avoid CNY devaluation and a chunky rally in the major Australian mining stocks are a boost for the Aussie, and heavy short speculative positioning could drive a further squeeze higher. Note that we are rapidly running out of room in the descending channel, a break of which could open up for 0.7500 or higher, even if we remain in a secular bear market.