- Sovereign bond spreads dictate forex moves
- No agreement expected at today’s Eurogroup meeting
- PBoC cuts rates for third time in seven months
- Commodity currencies not supported by Chinese policy
Volatility will always provide a degree of opportunity, currently something that investors cannot complain about. Last week, capital markets were exposed to massive sovereign bond yield swings that supported directional play in both the forex and equity space.
European government debt markets are usually considered relatively stable with intraday yields moving only a few hundredths of a percentage point a day. In less than three weeks, the “trade of a lifetime” saw German 10-year bund yields rally +75 basis points from record low yields (+0.05%). This price move is equivalent to three rate hikes and then some. If it’s not political (surprise U.K. election outcome and Greece), fundamental (nonfarm payrolls and Chinese rate cuts), then it’s been the positional play (record short-EUR positions on rate divergence) that has had required many investors to be prudent and rather agile.
Three regions and three trading themes will dominate the markets this week. The People’s Bank of China (PBoC) cut rates over the weekend, which indicates its concern about a protracted slowdown in China’s economy. Investors will have a ringside seat and get to see data on fixed-asset investment, industrial production, and retail sales from the world’s second-largest economy. Are we in the middle of a PBoC easing rate cycle or do we have much further to go?
In the eurozone, there is mounting optimism over an improving regional economy — that is to be confirmed by first-quarter data this week. However, the tense Greek negotiations will be capable of trumping everything at the moment. Does Greece have the €750 million it must repay the International Monetary Fund by Tuesday?
In the U.S., is the first-quarter slowdown part of a longer-term trend? Or is it merely a weather-influenced blip? Retail sales and industrial production data this week should go a long way in explaining to capital markets if the Federal Reserve is on course to hike rates by year’s end.
Greek Default Risk Heightened
Friday’s end of week price action in a number of major USD pairings could be interpreted as a signal that the recent dollar selloff is perhaps stalling. Obviously, the U.S nonfarm payrolls print for April (+223,000 jobs and a +5.4% unemployment rate) helped stop some of the recent dollar bleeding.
The EUR starts this week on the back foot as nerves have convinced some longs to liquidate ahead of today’s Eurogroup meeting. Renewed concern over Greece’s future in the eurozone will always produce headwinds for the euro.
No agreement is seen on Greece at this time, but European Union members are expecting progress to be evident in the negotiation process. The talks between the Greek government and its international partners are entering a crucial phase, overshadowed by a precarious fiscal situation, heavy debt redemption, and concerns about the stability of Greece’s banking system. A majority of the market expects a deal to be reached, but the failure to reach an agreement in the coming weeks could firmly put Greece on the Grexit path.
With the fixed-income market leading the forex moves of late, the EUR bull will be looking toward the rates market for support. A pleasant surprise for EUR long positions is that the two-year U.S.-German yield spread has narrowed -5 basis points since Friday’s jobs report, and with 10s at +158 basis points, they are in -3 basis points today and remain close to last week’s +152 basis points low. The EUR bear is required to break €1.1135 support with momentum before pointing to further losses toward €1.1055 and €1.0850.
PBoC Pulls the Trigger Again
Chinese policymakers cut rates again over the weekend, the third time they’ve done so in seven months. This time around it has caused little market reaction, mostly because of the size. The PBoC cut its main policy rate after soft trade and underwhelming consumer-price index (CPI) data.
April CPI inflation rose by a decimal to a four-month high of +1.5%, but still missed market expectations. The year-to-date CPI of +1.3% was also underwhelming, as it remains well below the official 2015 target of +3.0%. It’s worth noting that food CPI was once much higher at +2.7% versus +0.9% for non-food. Officials do indicate that supply of meat and fresh vegetables has been stable, so there are no expectations of a sharp jump in food prices in the near term.
The easing — a -25 basis points cut in deposit and lending rates to +2.25% and +5.10%, respectively — was widely expected by the market following last week’s downbeat trade numbers. The PBoC also noted it will continue to “promote real interest rates back toward reasonable levels” in response to the downward pressure the economy is facing.
The consensus is for further easing by the PBoC. But will looser policy in China provide support for commodity- and interest rate-sensitive currencies like the AUD, NZD, or CAD? The initial market reaction does not expect a looser policy in China to feed through to commodity currencies. The fixed-income market is pricing in a -50 basis points rate cut by the Reserve Bank of New Zealand by year’s end.
Meanwhile, Governor Glenn Stevens at the Reserve Bank of Australia continues his “dovish” talk, projecting higher unemployment, lower business investment, and a currency that’s overvalued.
Bank of Canada Governor Stephen Poloz is sitting on the sidelines waiting out the first half of the year, though “sunny Stephen” has projected a pickup in the second half of 2015. Canada’s jobs report published last Friday did produce a negative headline, but the bulk of the job losses were in the part-time sector. The only plus for the loonie is that crude oil prices have stabilized for the time being.