Watching key risk events; Labour market keeps US yields buoyant

Crunch time as the market look to UK elections, trade talks and FOMC meeting.
Philip Wee, Eugene Leow09 Dec 2019
    Photo credit: AFP Photo

    FX: Holding their breath ahead of key event risks

    The USD Index (DXY) is supported by its largest component, the euro. The Fed will, at its FOMC meeting on December 11, be comfortable with its pause stance to meet its dual mandate. There will be less pressure to resume rate cuts after last Friday’s surge in US nonfarm payrolls to 266k in November, its highest level since January. Thursday’s CPI data will provide no urgency to raise rates. DXY has held above the 97.2 low seen after the Fed’s last rate cut on October 30.

    Conversely, ECB President Christine Lagarde will have her work cut out for her during her first governing meeting on December 12. Lagarde views Eurozone growth as weak and in need of fiscal stimulus. She is expected to tone down rate cut expectations to heal the rift left by her predecessor’s departing monetary policy decisions and to win over Germany’s support. Until she does, Lagarde would also need to convince investors that the ECB has not exhausted its monetary toolkit. EURUSD has kept to a 1.10-1.11 range after Lagarde started her presidency.
    On the UK snap elections on December 12, GBPUSD has traded above 1.30 in anticipation of a Tory majority. Its upside is, however, likely to be capped at 1.35 by the still-weak UK economy and increased risks for rate cuts and debt rating downgrades. On the other, the odds of a hung parliament are not negligible either. If this emerges instead, GBPUJSD could plunge back into 1.25-1.30.

    The China-US Phase 1 trade deal remains elusive. China’s insistence for US tariff rollbacks remains a critical redline. US President Trump has warned that, without a deal, the US tariffs on Chinese goods will proceed as planned on December 15. If so, onshore and offshore USDCNY rates could revisit their September highs near 7.20. A surprise decision to delay the trade talks and hold off the planned US tariffs, however, could help keep USDCNY stable around 7.00-7.10.

    Rates: US macro backdrop keeping yields buoyant              

    Market participants will likely be cautious in this event-laden week as we seek a conclusion to China-US trade talks, Brexit and the final FOMC meeting for the year. Since September, US yields have been unwilling to push new lows with 10Y yields firmly stuck in the 1.5-2.0% trading range. However, with multiple risk events on the horizon, 10Y US yields were drifting lower before the blockbuster payrolls reversed this trend. Consensus expected a 180k print, but the actual turned out to be 266k. Moreover, there were 41k net positive revisions to payrolls. With wage growth holding up (3.1% YoY in November) and jobless claims drifting lower, the overall picture for the labour market is healthy despite the prolonged manufacturing drag.

    The market is already pricing in a reasonable chance of positive outcomes in both risk events (UK elections and China-US trade talks). If lingering uncertainties get removed, 10Y yields can probably drift towards 2%. However, a break above that level may prove challenging unless the global macro backdrop shows more concrete signs of revival. Similarly, while the market has pared back expectations of aggressive Fed easing, the pricing (1 cut by end-2020) is probably about appropriate at this point given that the likelihood of a cut is still higher than that of hikes in the coming few quarters. We are comfortable holding on to our view that the Fed will be on prolonged pause and see the Fed reiterating this via the dot plot on Thursday. Once global data turns for the better in 1H20, US yields can take another leg higher.

    Philip Wee

    FX Strategist - G3 & Asia


    Eugene Leow

    Rates Strategist - G3 & Asia

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