Taking stock before the G20, checking recent optimism with reality

With US fundamentals taking a backseat, technicals provide some clues on where 10Y US yields could head to. Apart from Fed cut expectations, the US dollar index (DXY) has been weighed by excessive opt...
Eugene Leow, Philip Wee24 Jun 2019
    Photo credit: AFP Photo

    Rates: Lighten up ahead of G20

    Investors locking in profits from long bonds position is likely to keep 10Y US Treasury yields above 2% in the immediate term. We noted that the rally in govvies looked stretched last week and yields did bounce modestly. In particular, investors appear to be more jittery about duration risks, with 10Y and 30Y yields up by 3bps and 4bps respectively on Friday. The G20 meeting at the end of the week (June 28-29) will be critical. While the best case scenario appears to be a China-US trade truce, the binary outcome (deal or no deal) makes it difficult for market participants to price-in risk sufficiently.

    With US fundamentals taking a backseat, technicals provide some clues on where 10Y US yields could head to. The recent leg of the bond rally took place when yield support at 2.35% broke on the back of the escalation in China-US trade tensions in May. We are doubtful that a full unwind can take place at this point. Positive news narrative on the trade front could take 10Y yields towards 2.15%. In any case, there has been moderation in US data and the market would likely keep pricing downside risk to policy rates (factoring in 2-3 cuts) even if a trade deal lessens the urgency of monetary easing.

    In Europe, 10Y German yields closed above -0.3% shortly after Draghi opened the door to further easing (quantitative easing and rate cuts). While the initial reaction to the dovish tone Draghi struck last week was lower yields, there appears to be some resistance to lower rates further across the curve. Market participants might be judging that scope for further easing is constrained and are reluctant to factor in aggressive European Central Bank (ECB) easing just yet.

    FX: Recent optimism questioned by a flight to safety

    The upside in the euro is likely to be capped just below 1.14 after a strong rally last week. The European Central Bank is closer than the Federal Reserve to lower rates in July. Both countries are scheduled to release their key inflation gauges on June 28. Consensus expects the May US PCE deflator and June EU CPI to remain unchanged at 1.5% YoY and 1.2% respectively, the same pace a month ago.

    Three Fed speakers – Chairman Jerome Powell, Presidents John Williams (New York) and Mary Daly (San Francisco) – are likely to reaffirm that the factors keeping US inflation below its symmetric 2% target, as transitory. The ECB is more dovish and is ready to provide additional stimulus if the sustained return of inflation to its aim is threatened. The US 10Y bond has not been able to stay below the Fed’s 2% inflation target but its EU counterpart has remained near record lows in negative territory.

    Apart from Fed cut expectations, the US dollar index (DXY) has been weighed by excessive optimism over the Xi-Trump meeting at the G20 Summit on June 28-29. China has no desire for another trade truce like the one struck at the previous G20 Summit in Bueno Aires. China requires consultations to be based on mutual respect, equality, mutual benefit and in good faith to achieve an agreement that does not sacrifice its right to development or undermine its sovereignty. This caution was best reflected the onshore CNY and the offshore CNH staying weak against the official mid-rate.

    There was also a flight to safety into gold from the US-Iran tensions in the Persian Gulf. Gold closed above USD1300/oz by the end-May and surged to USD1400 this morning. Brent crude oil prices have, in less than two weeks, increased to USD65/bbl from its USD60 low on June 12. The attack on oil tankers and a US spy drone occurred in the Strait of Hormuz where much of the world’s oil supply passes through. The last thing the weak world economy needs now is an oil shock adding to global trade tensions. The concern is best reflected by the renewed its safe-haven status of the Japanese yen which posted its strongest close since April 2018.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Philip Wee

    FX Strategist - G3 & Asia

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