Trade deal doubts; Multiple worries weighing on US yields

CNY faces trade deal doubts whileEUR is weighed byrecession risks . Risk events keep US yields low.
Philip Wee, Eugene Leow07 Oct 2019
    Photo credit: AFP Photo

    FX: Trade deal doubts; EU downside risks

    The Chinese yuan depreciated in the offshore market this morning as the odds remain low for a trade deal at the China-US talks that resume on October 11-12. Washington wants to get the whole deal done but Beijing is unwilling to do so without the US rolling back tariffs. China would want to assess if the Trump administration is serious about curbing US investments in China. Instead of structural reforms and security issues, China wants to focus on buying US agricultural products to narrow the bilateral US-China trade deficit. The Trump administration wants to discuss the Chinese yuan and currency manipulation this week too, potentially complicating discussions.

    The US dollar is trading on the softer side after last week’s disappointing ISM PMI readings. But thanks to the upside surprises in the US monthly jobs report last Friday, there is no urgency to dump the USD Index (DXY). Meanwhile, Eurozone recession fears have kept the euro, which accounts for almost 58% of the DXY, below 1.10. Germany may enter a technical recession and is facing increased calls to abandon its balanced budget rule and provide stimulus. The outlook was dampened last week further by US tariffs on EU cheese and wine.

    Rates: Multiple worries weighing down US yields                                                

    The prospect of a US economic slowdown added to the list of worries keeping market on the edge. With the ISM manufacturing and non-manufacturing numbers flashing weakness, market participants are sticking to bets that the Fed will ease by another 40bps (1.5 cuts) by the end of the year. Meanwhile, the upcoming China-US trade talks and looming hard Brexit deadline (end-October) suggests that sentiment is likely to be jittery and will likely keep UST yields depressed.

    US Treasuries are expensive by many measures. Real yields are low and the term premium is negligible (the curve is inverted or exceedingly flat, depending on the segments). Moreover, implied volatility (a measure of risk) for this asset class has climbed to levels not seen since 2016. Taken together, we think that USTs are risky and do not offer sufficient yield compensation for investors. Longer-term yields may be particularly vulnerable to a ramp-up in fiscal expenditure (across US and Eurozone) over the coming few quarters even as the Fed stays accommodative. This week’s 3Y, 10Y and 30Y auction will provide an indication of investor appetite at these depressed yield levels.


    Philip Wee

    FX Strategist - G3 & Asia


    Eugene Leow

    Rates Strategist - G3 & Asia

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