Reiterating caution on DM govvies; USD and FOMC
UST and German yields ended modestly higher but that fails to capture the sizable intraday turbulence in the wake of the European Central Bank’s (ECB) policy announcement and news that an interim China-US trade deal is being mulled. 10Y US Treasuries and German yields had intraday trading ranges of 13-14bps. While yields initially dived as market participants focused on the fact that asset purchases are going to be open ended, this move was reversed when it was revealed that there was considerable pushback against quantitative easing. Sentiment was also bolstered when positive news on the trade war front filtered through.
We reiterate our cautious view on duration,noting that DM rates may have traced a bottom 2-3 weeks ago when trade tensions and hard Brexit fears were acute. Flows are likely to be more balanced as the fiscal drumbeat in the Eurozone gets louder. In any case, DM yields at these depressed levels are vulnerable to pushbacks from central banks against overly loose monetary policy. The interplay between monetary policy and trade war dynamics bears watching. A trade war thaw could conceivable reduce the need for “insurance cuts.” We think the 2Y to 5Y segment of the curve (which is still aggressive factoring in cuts) may be most vulnerable to any shifts in Fed expectations.
FX: Scope to dial back excessive pessimism
The US dollar is staying weak ahead of next week’s FOMC meeting. Expectations have increased for the Fed to follow the dovish monetary policy moves by its European and Chinese counterparts. We, however, believe that the Fed would avoid a back-to-back cut on September 19 and lower rates on October 30 instead. The above Fed cut expectations were, however, enough to prevent the euro from closing below 1.10 on the ECB’s dovish measures – deposit rate cut and tiering, and the resumption of asset purchases – announced yesterday. China announced, on September 6, cuts in the banks’ reserve requirement ratios on September 16, October 15 and November 15.
The ground has been set for more progressive China-US trade talks in Washington in early October. While prospects for a prolonged trade war have not gone away, optimism for an “interim trade” deal has emerged. Apart from the concessions to delay tariffs, President Trump is considering rolling back tariffs in exchange for China’s commitment on intellectual property and purchases of US farm products. The US Treasury Department also wants to discuss, at the trade talks, the CNY’s depreciation after it labelled China a currency manipulator. Hence, pay close attention to the mid-rate for USDCNY which may start to drift below 7.08 towards 7.05.
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