Trade tensions matter more than US Currency Report; How low can US yields go?


Trade tensions matter more for FX than US Currency Report. US yields are dragged down by low developed market yields
Eugene Leow, Philip Wee29 May 2019
    Photo credit: AFP Photo


    FX: Trade tensions matter more than US Currency Report
     
    Two things stood out in the US Treasury Department’s Currency Report issued on May 28. First, two out of the three measures for currency manipulation were tightened. The pain threshold for the current account surplus was lowered to 2% from 3% of GDP. On one-sided currency interventions, the limit for net FX purchases has been untouched at 2% of GDP but the observation period has been tightened to 6-12 months from 8-12 months previously. The third criteria, a country’s bilateral trade surplus with the US, was unchanged at USD20bn. Second, the monitor list for currency manipulation was expanded to nine from six countries. China, Japan, South Korea and Germany stayed on the list. India and Switzerland were removed while two EU countries (Italy and Ireland) and three Southeast Asian countries (Singapore, Malaysia and Vietnam) were added. No country was designated a currency manipulator.
     
    Washington’s restraint in not labelling China a currency manipulator was a relief. Unfortunately, this would not be enough to offset the China-US trade tensions weighing on currencies. On a positive note, Beijing has provided some stability with its vigilance against speculative bets for the Chinese yuan to depreciate past 7 against the US dollar. This would help other Asian currencies such as South Korea and Indonesia that have intervened to smooth exchange rate volatility. But this would only address the symptoms and not the cause. Xi and Trump still need to meet at the G20 Summit on June 28-29 to thaw the freeze in trade talks. Washington and Beijing must heed the global growth risks signalled by the overnight fall in the US 10Y bond yield to 2.25% pushing for a Fed cut.
     
    Rates: How low can US yields go?

    Since breaking support at 2.36% last week, 10Y US yields continue to grind lower and are now below 2.30%. There are a couple of reference points that market participants are likely to gravitate to. Firstly, there is no clear support until the 2.0-2.1% level. Secondly, the market may be of the view that the forward curve is still too steep. In which case, it would make sense for 10Y yields to drift closer to where the 1Y3M rates are. With 2 cuts priced into the interest rates space in a year’s time, 2% seems to be a logical target. Clearly, these are simply technical targets with US fundamentals taking a backseat.


     
    Aside from negative trade war narrative, plunging German yields is the other key factor dragging US yields lower. By some measures, the rally in Bunds is even more impressive than that of US Treasuries. 10Y German yields, at -0.16%, is hovering barely 3bps off its all-time low of -0.19% registered in mid-2016. If this level gets breached, a further decline towards the deposit rate at -0.4% is likely. The market is anticipating a dovish response from the European Central Bank (ECB) and this will inevitably spillover unto US rates. The correlation between the US and German 10Y yields is high and underscores the point that US yields also reflect how well the global economy is doing. If Eurozone and Chinese data stay lacklustre, US yields are going to be anchored.

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

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