Opposing forces at play in the rates and FX spaces

The British pound is in limbo with no factors strong enough to push it below 1.20 or above 1.25 against the greenback.The Chinese yuan is likely to be stable in a 7.00-7.20 range ahead of the Washingt...
Philip Wee, Duncan Tan09 Sep 2019
    Photo credit: AFP Photo


    FX: GBP and CNY are in limbo

    The British pound is in limbo with no factors strong enough to push it below 1.20 or above 1.25 against the greenback. There is no conviction if Prime Minister Boris Johnson will be able to lead the UK out of the EU on October 31 with or without a deal. Neither is anyone sure that MPs can, with the newly passed law to block a no-deal Brexit, force PM Johnson to ask Brussels for another Brexit extension. Parliament has also rejected PM Johnson’s push for an early election in October. The High Court has, on the other hand, rejected the legal challenge to the five-week parliament shutdown scheduled to start this week. A no-deal Brexit can still happen by default if MPs push for a no confidence vote against PM Johnson.

    The Chinese yuan is likely to be stable in a 7.00-7.20 range ahead of the Washington trade negotiations scheduled for early October. While relieved both sides have resumed talks, expectations are low for any breakthrough to reach a trade deal. The Shanghai trade negotiations in late July ended in mutual criticisms and was followed by the US Treasury Department labelling China a currency manipulator in August and President Donald Trump announcing more tariffs on Chinese goods. The bias for the CNY to stay weak past the psychological 7 level remains intact. Scars of the trade war were evident in China’s negative August trade numbers and the latest reserve requirement ratio cut to cushion growth that is set to slow to the floor of this year’s 6.0-6.5% official growth forecast.

    Rates: Relatives, not absolutes in Europe

    The entire yield curves of highest-rated Germany and Netherlands are submerged below zero. Better-rated sovereigns like Austria and France (both AA) have sub-zero yields up to the 15Y tenor. Even lower-rated sovereigns like Portugal (BBB) are yielding negative up to the 7Y tenor. In this environment, its mostly about relatives. On an absolute basis, 5Y Portuguese yields may look too low at -0.30%, for an issuer that is rated just one notch above junk. But when one considers that it offers a 59bps yield premium over 5Y German Bunds (-0.89%), Portugal bonds don't look as expensive now. Therefore, the rising trend of negative corporate bond yields should not be seen as an anomaly, but rather something that is here to stay.

    European corporate bond yields, especially IG, could fall further on a combination of lower German Bund yields and/or credit spread compression.

    1. In the EUR space, with much of sovereign yields in negative territory, investors who need positive yields would be forced to buy more corporate bonds. This is in contrast with the USD space where investors still have a risk free asset (US Treasury) that yields positive.
    2. How much further can corporate bond yields fall? That will largely depend on the duration and pace of ECB's Asset Purchase Programme (APP) (expected), especially the corporate sector component (CSPP) where they buy IG corporate bonds. Markets have already started to price, in advance, for APP and CSPP, judging by how sovereign and credit spreads have been tightening. However, we think that this incremental pricing could still have some way to go, even post announcement of APP.

    Philip Wee

    FX Strategist - G3 & Asia

    Duncan Tan

    FX and Rates Strategist - Asean

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