Goldilocks US data and friendlier CNY needed; central bank easing not positive for all bonds

To sustain the recovery in risk appetite, investors will prefer a “Goldilocks” US jobs data and trade friendlier CNY. Until market volatility truly subsides, present times call for prudenc...
Philip Wee, Duncan Tan06 Sep 2019
    Photo credit: AFP Photo

    FX: Looking for a “Goldilocks” US job report and trade friendlier CNY

    The USD Index (DXY) has retreated from its 28-month of 99 seen on September 3. Risk appetite has improved on an easing in geopolitical risks, hopes for more monetary and fiscal stimulus and the resumption of China-US trade talks in early October. Major US stock indices rallied 1.3-1.7% in overnight markets while the US 10Y bond yield bounced to 1.56% from Tuesday’s 1.46% low, above 1.50% for the first time since August 26.

    Hence, investors will be prefer a “Goldilocks” outcome (160k consensus vs 164k previous) in tonight’s August US nonfarm payrolls.  ADP employment, which increased to 195k from 142k for the comparable periods, suggests possible upside surprises. On the other hand, the more reliable ISM employment sub-indices have decelerated to 47.4 from 51.7 for manufacturing, and to 53.1 from 56.2 for non-manufacturing.

    A relatively stronger US economy is viewed as counterproductive for trade talks because it encourages US President Trump to play hardball and push back Fed cut expectations. The Chinese yuan could also provide a more conducive back drop for trade talks. There is scope for a pullback in USDCNY after its strong run from 6.70 towards 7.15 in the past five months. Letting the mid-rate to be stable around 7.085 in the past week has been helpful in allaying depreciation pressures by guiding the offshore 12M NDF outright below 7.20.

    Rates: Tide of central bank easing may not lift all boats

    As the external environment deteriorates, our confidence around the future performance of EM Asia sovereign bonds has declined. In our view, present times call for prudence and careful selection of higher-quality bonds that would stay resilient under difficult circumstances (e.g. deepening of global slowdown, prolonged US-China hostilities, competitive currency devaluation scenarios etc). Performances across EM Asia bonds since August is probably telling. We recall that the announcement of new tariffs between US and China and higher RMB volatility, last month, had weighed on Asian markets.

    First, the performance of EM Asia bonds has lagged global core bonds (UST, Bund, JGB) despite increased market pricing of central bank easing. Second, EM Asia bonds recorded good fixed income returns but that offset by currency depreciation.

    Wary of such risks, we had shared our thoughts in a note in early-June (link). This centred around choosing high-quality bonds that are likely to rally (in local currency terms) in case of further US-China escalations, while FX exposures were hedged by swapping to USD or investors' base currency. We believe this playbook will continue to serve bond investors well over the medium term. In addition, we caution against inferring that Fed/ECB/BOJ support will lift all boats, particularly in the context of Asian bonds. With market volatility much higher in recent weeks, EM high-betas would be most at risk. The yield advantage they offer may not be sufficient to compensate for the extent of underperformance during bouts of risk aversion.


    Philip Wee

    FX Strategist - G3 & Asia


    Duncan Tan

    FX and Rates Strategist - Asean

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