Chart of the Day

For breakout traders this is an absolute cracker as the bull flag has now obviously complete, providing a decent medium-term upside in itself. Price has now broken the near-term high of 1.7194 and now needs a clean break of the January spike high of 1.7209, and ideally, we’d want to see a re-test to confirm this breakout is now support. The prospect of a stop run through 1.7209 is a risk, so I wouldn’t want to get caught here, but the momentum behind the pair gives an elevated view that this could be closer to 1.7300/50 in the next week or so. If we assess implied volatility, we can see the expected move in the next two weeks is 92-pips, so hardly explosive range expansion.

Some have focused on the daily of EURAUD too, but with Aussie employment data due tomorrow at 11:30AEST, with an elevated risk for a strong election fuelled print of above 16,000, the preference is to shy away from AUD short exposure.

We’ve discussed global rates and trade tensions in some depth of late, but news that was undoubtedly a key feature yesterday was the idea of renewed China stimulus. We saw the China CSI 300 index close up 3%, with A50 index (CN50) closing 2.5% higher. The Chinese government will now allow local governments to use select bonds as capital to finance projects, leading traders to feel credit growth is once again is on the up. We also saw news that the PBoC is issuing short-term bills in Hong Kong, which could withdraw liquidity from the market, and that is having the effect of promoting a strong bid in CNH (offshore yuan).

As we see in the daily chart of USDCNH, and once again traders have faded the move into the top of the consolidation range. The PBoC has guided the CNY somewhat stronger than market expectations in the past few days, and that seems to be sending a message that the central bank is keen to curb the upside.

China CN50 index

For those who haven’t looked at this market, it is effectively the top 50 China mainland stocks packaged as futures market and traded on the Singapore futures exchange. It is one of the cleanest vehicles to express a view on Chinese stocks.  As we can see, momentum is to the upside, and the price is threatening to break out of the consolidation range. It feels as though a weaker USDCNH (or USDCNY) should promote a further move higher in the CN50 index.

Trump’s comments overnight could take some of the wind out of the Chinese equity sail, with a tweet that he, himself, is holding up the deal with the Chinese, and that a trade deal won’t happen unless China agrees to the original terms, we saw a couple of months ago. We understand that Xi and Trump will meet at the G20, but Trump’s comments suggest they are a long way from convergence. All part of his game theory? Push the Fed into easing rates, do a deal with Mexico, and China and, off we go into the 2020 elections!

Outside of Chinese markets, I have focused on a number of charts that seem incredibly important for macro traders. They may/may not have come up on your radar, and if you want clarification on any of them do reach out.

Eurodollar three-month futures

We head into the June FOMC meeting on 20 June with traders expecting the door to be opened for an easing cycle from the Fed. If I look at the weekly Commitment of Traders report, and the level of positioning in eurodollar futures (a tradeable interest rate product) is at the highest net long position since 2008 – clearly a very crowded trade. As mentioned in my event risk video yesterday, if the Fed doesn’t meet the market pricing and the degree of easing expected from the rates market, then the USD is going to fly on 20 June. This chart shows just how crowded the rate cut trade is.

Source: Bloomberg

Rate cut expectations

Here I have looked at the spread, and therefore rate cut expectations, between the rolling front-month fed funds future (another tradeable interest rate product) vs the rolling fifth month. At this point in time rate cut expectations between June and October sit at 37bp (the Fed usually cut in increments of 25bp or 0.25ppt). The green circles show levels where we have often seen an easing cycle, and at current pricing, we are somewhere in-line. The market is expecting an easing cycle.

Source: Bloomberg

The liquidity effect

Fed excess reserves (green – inverted) vs the USD index (USDX on MT4/5). As suggested in the video, the prospect of the Fed announcing a formal end to its balance sheet normalisation program in June, as opposed to October, could be big news for the USD. We can see the relationship between excess USD reserves and the USD, and should we see excess reserves increase (i.e. the green line falls), then one would expect the USD to face headwinds over time. Liquidity, as they say, is the oxygen of markets and the driver of USD.

Source: Bloomberg

12-month US recession probability

So much has been made about the US yield curve and the recessionary environment expressed here. Here is the NY Fed implied recession probability model, which at 29% is the highest since 2007. The red shaded areas represent periods of prior recessions. 29% may not sound like a lot, but as we can see, this is where the probability stood in all eight of the previous recessions. It feels as though the rates markets are taking this as gospel and has made its mind up.

Source: Bloomberg

Tomorrow I will throw some charts out there that are great leading indicators, and they don’t support the notion of a recession — one for the optimists.

Inflation risks

At 22:30 AEST tonight we get US core and headline CPI. With the market searching for further clues on a July rate cut, this could be an event risk to pay homage too. Here we see:

  • White line – NY Fed inflation gauge
  • Purple – CPI inflation
  • Blue – core PCE inflation
Source: Bloomberg

With the consensus calling for 2.1% (core) and 1.9% (headline), we can assess how the USD will likely trade on the extent of the beat or miss.

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Chris Weston, Head of Research at Pepperstone

Two Must-Watch Dates for your Diary

Consider the two dominant macro influences, the first being trade tensions, and the second, the anticipated easing cycle from many developed and emerging market central banks. The two are obviously connected, but after Friday’s weak US payrolls report and concerning global manufacturing PMIs, they can be considered independent.

We live in a world where market participants focus on a macro thematic, and trade towards an outcome, as they see fit. We crave answers to justify the pricing structure and the validation that we’re on the right path – that time is now, and we eye the June FOMC meeting and G20 leaders’ summit. In the video, I put the two events on the radar, as they are going to get increased focus. Specifically, with 78 basis points (three rate cuts) priced in over the coming 12 months, the FOMC statement, as well as Fed chair Powell’s press conference simply has to open the door to cuts. It has to be sufficiently dovish to validate this rates position, or we will see the USD rally, and equities under heavy pressure, with implied volatility spiking.

Prior G20 meetings have been forums for some significant initiatives, so there will be increasing expectations for convergence between Xi and Trump. That said, there is no guarantee the two leaders will even meet, with Trump detailing overnight that he will place tariffs on the $300b of Chinese exports (to the US) if that is the case. One suspects they will meet, however, and the market will, therefore, be sensitive to any narrative that the two are coming together to get a deal done.

Source: Goldman Sachs

While it easy to focus on the potential reaction should the Fed not meet the market pricing, a world where the Fed signal an intent to ease married with a better feel to US-Sino relations, is a world where traders take additional risk.

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Chris Weston, Head of Research at Pepperstone

We Close Out the Week on Fairly Optimistic Tone in Equities

The strong consensus view is that we will see a cut in July, with the probability of a cut here, dropping a touch to 78.7% probability this morning, after having adjusted and reacted to the news Trump was suspending implementing the 5% tariff on Mexico. We can look across the fed fund futures curve and see a move of some 6-basis points higher in the contracts past September, with US 2-year Treasuries gaining 4bp, with 10-year Treasury futures up 3bp – this needs close attention as buyers are starting to emerge. The USD is up smalls vs all G10 FX, except the NOK, which is benefiting from a 0.3% gain in Brent futures.

The Mexican peso finds relief buying

In FX markets, most of the focus has been on USDMXN though, and a 1.9% sell-off will in no way surprise, as before Friday, it was widely seen that Trump would lift tariffs on its Central American neighbour. Nasdaq and S&P 500 futures are both up 0.3%, indicating we should see the S&P 500 cash opening around 2880 and a possible test the 10 and 16 May high 2891/2 in the near-term, but we see both futures market drift toward the flat line. The Nikkei 225 (+1.2%) is also overlooking to Friday’s sell-off in USDJPY, with the Hang Seng 1.9% higher. 

Mexico clearly made the right moves, and Trump felt appeased, although there is no mistaking that the administration would have seen the deterioration in broad financial conditions through May as a litmus test. When you look to alter the dynamic of decades of globalisation and supply chains and accelerate the fragmentation of relationships, the market will tell you how they feel about it, and they have. We would have seen higher implied volatility if it weren’t for the fact the Fed, ECB, RBA, and others, have expressed a firm view that they would all act appropriately to maintain the economic expansion.

Source: Bloomberg

Interestingly, USDMXN 1-week implied volatility has dropped a touch, but at 14.05% it suggests options traders are still very much on edge and pricing in punchy moves through this period. It begs the question of whether today’s gap in USDMXN will be filled and by when. Certainly one to watch, although, whether we can use this cross as a guide around trade tensions is becoming less clear, and perhaps we need to revert to USDCNH as the focus is back on the China-US relationship and whether we see tariffs of between 10% to 25% on the $300b tranche of Chinese exports. Comments from PBoC governor Yi Gang (in a Bloomberg interview) that there is “obviously a link between the trade war and the movement in the renminbi” have suggested its back to watching this cross.

USDCNH ready to break out?

USDCNH has seen small buying on the open of the new week, where the pair is eyeing a breakout of the 6.9500 to 6.9000 consolidation range (see chart below). Options traders see upside, with USDCNH 1-week risk reversals (the difference between options call volatility over put volatility) sits at 0.4175, having come off a high of 1.5 on 9 May and a what was a huge belief that USDCNH trades higher. We saw China’s May trade data far earlier in the session than usual, and the numbers will only add weight to those seeing further economic fragility. A 8.5% decline in imports throws up increased concerns about the China demand story, and while we saw a better-than-expected 1.1% gain in exports, although it’s still not going to excite.

US Treasury Secretary, Steven Mnuchin, tweeted overnight that he had a constructive and candid conversation with PBoC governor Yi Gang at weekend G20 finance ministers meeting, and that the focus should turn to the G20 leaders’ summit on 28/29 June. We await this meeting intently.

Where to for the greenback?

The question I find fascinating is with such aggressive easing priced into global rates/swaps markets and the front-end of bond markets, is where does the USD trade from here? Consider over the coming 12-months swaps markets are pricing 77bp (over three) of rate cuts in the US, 35 bp in Canada, 21bp in Europe (as well as revisiting QE), 51bp in Australia and 48bp in New Zealand. I can go on, but the market has made up its mind on the global economy and demanding action.

Granted, the likes of the RBA and RBNZ have already started its easing cycle, and we should consider QE in Europe ahead of rate cuts, and the impact balance sheet expansion has on a currency. But the desire for a weaker currency, as a by-product from easing, is front and centre, and has led many to refocus on the notion of currency wars. It will be a huge theme in the G20 leaders’ summit, but there is little doubt that the world could use a weaker USD, although with the world moving in alignment that is in no way guaranteed. 

The USD tends to head lower around five weeks or so before a Fed rate cut, and that may play out this time around. The USD also declines if traders feel the US economy is the issue at the core, and by not putting up tariffs on Mexico that risk has been modestly hosed down. However, the risk remains and the aside from tweets and statements on trade, the 19 June FOMC meeting and the G20 meeting.

Chris Weston, Head of Research at Pepperstone

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The Markets Have Made Up their Mind about Where the Global Economy is Going

We’ve all been talking about the dour message various developed market yield curves have portrayed for some time, and the moves in DM bonds and rates have been huge this year, and while this is a crowded and much-loved trade, there could be more to come. We see 70bp of cuts (nearly three rate cuts) priced into the fed funds futures curve this year, with the 31 July FOMC meeting now priced at 69% for the cut. As suggested yesterday, a June cut is priced at around a one-in-four chance, and that could head towards 35%-40% if we get a weak US payrolls report on Friday, but it really feels that the July to September window is when the Fed cut. The fact that it is becoming more certain Trump slaps a 5% tariff on Mexican exports in four days only accelerates that view.

All eyes on US payrolls, with big ramifications on a weak number 

There is certainly no belief we will see a weak payrolls report on Friday, and ok, we saw a poor 27,000 jobs created in the ADP payrolls report last night (vs 185,000 excepted), which coincidentally was the lowest level since 2009. However, if you look at the employment sub-component of the US services ISM, this increased by a sizeable 4.4 points to 58.1, and perhaps this is the better precursor for Friday’s payrolls.

For the statisticians out there, we can run a long-term regression using the ADP payrolls monthly data as our independent variable and the non-farm payrolls monthly data as our dependent and see the test is largely irrelevant. A mere 19% of the variability in US payrolls can be explained by the ADP print, and therefore, it’s not hard to see the market really fail to react to the ADP print. I would be more aligned to the ISM service data as our lead, given the US is a service-led economy. Either way, we have a mixed lead into what could be a volatility event. With the Fed putting such huge weight to the US labour market, any convincing signs that cracks may be appearing and it is on. The ever more dovish position in the rates market will solidify, front-end yields will head lower, and the cleanest FX play will be USDJPY, which will smash through 108.

Gold rallying in every G10 currency – bullish 

Gold has been getting ever growing attention, and I focused on this on the 30th May, suggesting that gold in EUR and AUD terms (see chart below) could be the better trade, gold in USD terms is also clearly working well. Gold in AUD terms has broken to all-time highs and holding the 5-day EMA, although we are seeing better sellers today, as we are in USD gold, which continues to hug the upper Bollinger band, as realised volatility rises.

I was hesitant to call gold higher in USD terms, but since that call, the market has had a huge re-think and felt on balance that perhaps it’s the US we should be worried about. Not so much China or even Europe, but the US, and that is why the USD has underperformed since 30 May, as it part plays catch-up to rates pricing. Either way, gold is going up in every G10 currency, and you can’t get much more bullish than that, having also firmly re-established its correlation with ‘real’ of inflation-adjusted US bond yields, and while I have inverted (or flipped) gold, we can see the move is almost tick-for-tick.

The near-term risk then sits around US payrolls and a weak number, with the unemployment rate headed to say 3.8%, a payrolls report of fewer than 130,000 jobs, and weaker wage pressures and gold should be headed to $1350. Of course, a strong payrolls report and things get a little messy as the market is positioned for a dovish shift from the bulk of the Fed in the weeks ahead, and that requires a weak payrolls report.

Consider USDCHF, which is a trade I have been focused on. On the daily, we can see huge support below 0.9900 and yesterday’s candle highlighted this case-in-point. Granted, the fundamental players out there all scream out how ‘expensive’ the swissy is, and that is true on any traditional valuation metric. However, if we see a close below 0.99, it would be a powerful signal in my view, as the defence here throughout 2019 has been there for all to see.

An ECB meeting preview

We have to wait until 19 June for the Fed meeting, but tonight at 21:45 AEST we hear from Mario Draghi and the ECB. It will not surprise that EURUSD overnight implied volatility is the highest since November as the market is on edge and while the expected move on the session is 66p, which puts a range of 1.1161 to 1.1293 in play. However, we still watch for a daily close through 1.1265 – the neckline of the double bottom (on the daily chart) and should this pattern complete then the target would be north of 1.1400. The market seems unsure though, with yesterday’s candle printing an outside period and thus yesterday’s low of 1.1220 gets some focus. So, while we watch price action to understand the flow of capital, we are really at the mercy of what is or isn’t said from the soon-to-be outgoing ECB president.

EURUSD overnight implied volatility. Source: Bloomberg

With EU 5-year inflation swaps at a lowly 1.29%, there is absolutely no reason to strike anything but a dovish cord, and the market is positioned for this. That said, the European labour market has shown signs of improvement and even wage pressures, and should Draghi dwell on this it could cause the EUR to rally. That said, there are brewing tail risks in Italy that may require greater attention in the future, and we may see trade tensions between Germany and the US become a major thematic, so that suggests staying ahead of the curve and a steely determination to convince us, market participants, they have the necessary toolkit to stave off a greater shock.

At the least, we expect its forward guidance for when rates head higher to be pushed out to 2020, as well as amendments to resemble that “growth risks are to the downside”, as opposed to the past guidance that “growth risks are still tilted to the downside”. We watch for further details on its free money program aimed at supplying liquidity to the European banks for a fixed term, commonly known as the TLTRO program. There could even be an increased conversation another round of QE, although most expect this closer to September.

Peterborough by-elections are symbolic

Also, keep an eye on GBP over the next 12 hours or so, with the Peterborough by-elections taking place. In any other situation, this would be a non-event for markets, but it is now symbolic, in that the Brexit party, led by Nigel Farage, is expected to win here and therefore gain its first seat in the Commons. It again feeds into the notion that UK politics is focused solely on ‘no deal’ or ‘no Brexit’ and there is no place for a centrist party. This could also define the picture for the start of next weeks Tory party leadership challenge, and a huge showing for Farage will only galvanise the view that the next Tory party leader needs to be a firm no Brexit leader. It is making fascinating viewing, especially with Labour moving to a more ‘remain’ view. October will be the showdown.

Chris Weston, Head of Research at Pepperstone

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Key Risk Events for June

I hope it helps put a few key events on your radar I feel could shape the narrative.

Chart to watch

EURUSD (daily chart) – It’s hard to be long EURUSD with the ECB meeting in play tomorrow (21:45aest), but price is currently testing the neckline of the double bottom (1.1264), and with triple divergence, one of the best reversal indicators, potentially playing out, we could be eyeing a technical long for a move above 1.1400 shortly. This could have far-reaching implications for global markets, albeit a bit more work needs to take play out in the move. 

Looking ahead at the key risk events for June

ECB rate decision (6 June)

In reality, no one expects the ECB to change interest rates, but we could easily see Mario Draghi, once again, push out the banks forward guidance on when rate hikes are expected to go up. Currently, the bank has committed to keeping interest rates at current levels until at least the end-2019. However, the risk is that this guidance is pushed out into 2020, or we could even see the calendar-based guidance removed altogether. But a failure to push out its view on rates could be seen as a EUR positive.

EURCHF weekly – Will this bounce off or crash through key support?

If we look at EU inflation expectations (see chart below), an input the ECB look at closely, we can see expectations have fallen to 1.31% and the lowest levels since 2016. So, one questions how the ECB can be anything but dovish and is a growing consideration for the ECB, with the market questioning if we get colour on the ECB’s appetite to restart its asset purchase program. There will also be focus on any further clarity on the targeted liquidity program to European banks.
The ECB aggressively lowered its growth forecasts in the March meeting to 1.1%, so it would surprise if they went downgraded expectations again, but the market will be keen to assess any new changes to its growth and inflation forecasts.

(Source: Bloomberg)

May Nonfarm Payrolls (7 June 12.30 GMT)

US Nonfarm payrolls US Unemployment rate

Forecast 183,000

Previous 263,000

Forecast 3.60%

Previous 3.60%

Traders always anticipate the US non-farm payrolls report as a potential volatility event and given the growing calls for tougher economic conditions in the US, the last thing the USD bulls want to see is an unexpected deterioration in the labour market. We can see that the consensus estimate sits at a healthy 183,000 net jobs (economist range 215,000 to 80,000) created in May, which is a slight discount to the six-month average of 209,000 and one-year average of 214,000. As always, the magnitude of moves in the USD and US equity markets will be driven by the extent of the beat/miss relative to this consensus figure.

Daily chart of the USD index/USDX

The unemployment rate is probably the more influential variable to the Fed though, given the importance of the labour market for Fed thinking. Again, it seems unlikely to concern traders too much unless the unemployment rate comes in above of 3.8%, which would be a surprise and one would then have to consider the influence of the participation rate here. The fact that the US unemployment rate sits at a multi-decade low unemployment rate is simply not resulting in significant wage pressure, which is the backbone of the Fed’s assessment of inflation. With this in mind, keep an eye on average hourly earnings which is expected to remain at 3.2% and again, if this comes in hotter or colder could have an influence on the USD.

  • White histogram – Net monthly change in US payrolls
  • Red line – average hourly wages (YoY)
Source: Bloomberg

EU Summit (20 June)

With Mario Draghi due to step down as ECB president on 31 October, there is much speculation as to who could be Draghi’s replacement. The market has seen time-and-time again that when it comes to producing dovish surprises, Draghi wears the crown as king of the central bank doves. It has become almost too predictable that the EUR will fall in the wake of Draghi’s speeches. There is some market chatter that we could get an announcement of Draghi’s successor at this EU Summit, and with monetary hawk, Jens Weidmann considered a front runner, perhaps this Summit could prove to be a volatility event for the EUR and German DAX.

With genuine concern that the ECB lacks have the monetary toolkit to navigate the Eurozone through another major economic downturn, who leads this organisation really matters to FX pricing.

G20 meeting (28/29 June)

With trade relations at the epi-centre of markets, and Trump seemingly taking on all comers, the market is looking for a circuit breaker, and an excuse to cover shorts and put risk back on the table. While it hasn’t been confirmed, there is much speculation President Trump and Xi could meet face-to-face in Japan, with the risk skewed that we finally see some convergence in the narrative and a bond to achieve a deal. At this stage, Trump’s action is breeding huge uncertainty not just in markets, where the talk has moved from ‘if’ to ‘when’ we will see the first rate cut in this cycle from the Fed. But, more prominently at a corporate level, so how Trump interacts with Xi, should it play out makes this event a must-watch.

OPEC meeting (Vienna – 25/26 June)

Oil markets have been savaged since 23 April, with traders focused on poor China demand indicators, amid the backdrop of broad negative financial market sentiment, better supplied US inventories and supply dynamics driven by risks in Iran, Libya and Venezuela. Compounding the poor sentiment towards crude, Russian authorities have raised concerns about its ongoing commitment for production curbs of production.
With WTI crude (XTIUSD) eyeing a possible test of $50 and Brent $60, the market will be keen to assess if OPEC tries and get in front of the move lower and support prices. How crude tracks from here will not just have huge implications for equities, but, in FX markets, a lower oil price means headwinds for the NOK, CAD and a lower USDJPY, given the impact oil has on US inflation expectations. And, vice versa.

Source: Bloomberg

The June Federal Reserve meeting (19 June)

Arguably the marquee event through June, and an event risk for most of Pepperstone’s tradable markets. It’s incredible how quickly things have deteriorated, with US interest rates now pricing 2.5 rate cuts this year. While some would say the move in rates pricing has gone a little too far, we head into the June FOMC meeting with the implied probability of a cut now set at 20%, although it feels far too early to really expect a cut and we look at the 31 July FOMC meeting as a truly ‘live’ meeting, with expectations for a cut currently at 62%.

The influence US interest pricing is having on USDJPY

  • Red line – Interest rate cuts (basis points) priced between June and December 2019
  • Yellow line – USDJPY

Fed vice chair Richard Clarida offered insight in a speech (on 30 May) that the US economy “is in a good place”, however, he did caveat that by saying that should inflation remain below target and global conditions change, then the Fed should assess its policy stance. St Louis Fed president James Bullard went one further with narrative (on 3 June) that “a downward policy rate adjustment may be warranted soon to help re-centre inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown.”

Importantly, we have also heard from Fed governor Powell (4 June), who detailed “closely monitoring the implications of these developments for the US economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labour market and inflation near our symmetric 2% objective.”

The idea the Fed will act as “appropriate” is interesting and while it doesn’t suggest the bank are looking at cutting anytime soon, if economics do respond then we will see cuts. The June FOMC meeting should explore this in more detail with the help of additional data.

Chris Weston, Head of Research at Pepperstone

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The RBA ease and provide enough flexibility to satisfy a dovish market

Considering as the swaps market had priced in 70bp of cuts (nearly three cuts) over the coming 12 months, and considering the lack of determination to meet the markets dovish thought-process in this statement, we could argue the 17p rally in AUDUSD into 0.6993 and a 2bp rise to 1.14% in 3-year Aussie bond yields were a tad lightweight. Especially given the record AUD short position held by asset managers. I personally felt a non-committal statement could have seen a move above the 70-handle, but that hasn’t happened, and we have actually seen traders fade the modest strength. Let’s see how Europe trade this, but it would not surprise to see AUDUSD above 70c when we walk into work tomorrow.

Dr. Lowe’s speech should provide more colour

Governor Lowe speaks at 19:30aest and we may get more meat on the bone here to work with, but what the statement has done though is provide flexibility and now they have cut to 1.25% and met the conditions and roadmap by which Dr Lowe laid out to ease, the RBA have gained an element of credibility. Or, at least, mitigated a wave of condemnation had they not eased. The governor simply can’t give us the trigger points, we see these variables play out and subsequently price in 100% chance of a cut, for them then not deliver. However, the markets feel the bank ease again and continue to watch the labour market (next employment print is on 16 June), housing metric (auction rates, credit, prices), and, of course, external factors that can impact broad financial conditions and semantics, such as Trump taking on all comers.

The holy trinity of housing stabilisers

Housing is an incredibly interesting variable and a far slower moving beast than FX, rates and equity, but should we see consistent stabilisation of house prices, then we need to re-think this major domestic tail risk for the economy and markets. The re-election of the Morrison government, and the potential roll-out of a loan deposit scheme, and certainty around a continuation of negative gearing can now be married with monetary stimulus from the central bank. And, with it the potential for mortgage rates to eventually head below 3%. That said, ANZ has passed on 18bp (of the 25bp) and naturally faced the scorn of Josh Frydenberg, while CBA has picked up some needed PR and delivered the 25bp.

Changes from APRA to remove the minimum 7% serviceability buffer will also increase the maximum borrowing capacity, and we are dealt with the holy trinity of housing stabilisers. We keep our eyes on auction clearance rates and upcoming house price index.

Expect a weak Q1 GDP print

We watch for tomorrows Q1 GDP print, but it will be weak, and if it comes in above 0.4% QoQ we’d be surprised – and this in itself will result in the lowest year-on-year pace since Q3 2009. It seems as though this will fail to be a volatility event for markets, although a strong number could cement the support above 70c. Consider that the onus falls back on the US, with the market now saying that China or Europe is no longer the problem – Trump’s policies are going to need the biggest monetary response from the Fed or any central bank and that makes the US the number one global macro issue now.

Chris Weston, Head of Research at Pepperstone

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A question ‘when’, not ‘if’ the Fed cut

It has also resulted in S&P 500 futures opening 0.5% lower this morning, with the ASX 200 unwinding -0.5%, building on ever-growing calls that a recession, perhaps more specifically in Europe and the US, is fast becoming the base case if Trump continues with his current trade policies. The message portrayed in the developed bond markets is absolutely telling and that many have suggested portrays a view that we are headed for far tougher economic times that will require a punchier response from central banks – it seems this near-term tightening of financial conditions could well be the catalyst now. 

NY fed recession probability model. Source: Bloomberg

Fair play to rates and bond traders, as when equities were trending higher through May, rate cuts were never really priced out, and the dovish message never wavered.

Front loaded rate cuts

The moves on Friday were huge though, with UST 2s and 5s falling 14bp and 11bp respectively. The longer end of the curve underperformed, with the 2s10s curve gaining 5bp to 20bp, and this is a function of what we have seen front and centre in US rates pricing, where we see 46bp of cuts priced in between June and December, with a further 13bp (of cuts) priced in on Friday alone. Interestingly, we can now see more aggressive easing (from the Fed) priced for this year, than 2020 (40bp), which is new and reeks of a market that understands the need to front-load cuts. 

The fact that we now see JP Morgan, Barclays and Credit Suisse all calling for easing as their base case and we are seeing economists call for easing is a theme I had suggested to look out for last week and is now playing out. Now we can caveat this by saying the degree of cuts is largely conditional on the US trade administration actually rolling out 25% tariffs on the $300b of Chinese exports, and implementing the starting rate tariffs of 5% on Mexican imports on 10 June, and potentially towards 25% after incremental rises.

A war on two fronts

Now, some have argued these measures against Mexico are a tool to get the Democrats to push through USMCA (United States–Mexico–Canada Agreement), but this agreement is looking more and more like a non-starter now. The bigger issue for markets is that firstly Trump is sending a message that perhaps he is prepared to tolerate a lower stock market .

Secondly, China and Mexico have accounted for some 30% of total US imports, and should we see all Mexican and Chinese imports taxed at 25% that’s $225.5b of new income for the US Treasury, however, these goods could cost US businesses 25% more. So, while US corporates doing business with China have had a while to review their supply chains and adapt, one could argue the moves against Mexico were not as well telegraphed, and for US businesses dealing with Mexico, this may become a more significant headwind. 

We know sentiment towards the global bond market is at an extreme, not just through assessing traditional oscillators such as RSIs, which can give us a rough idea on the risk to reward trade-off, but also through options pricing. Here, we see the demand for call volatility (in US Treasury futures) pulling away from put vols (see the lower pane in the Bloomberg chart below), with the spread moving to the widest seen in 2019. This tells me that traders are positioned for further gains in bonds and that we are going to see a dovish turn from the Fed soon.

This flow could even accelerate if financial conditions tighten sufficiently this week, and we see a weaker China Caixan manufacturing PMI print (11:45aest – 50.0 consensus) and US manufacturing PMI (00:00 aest – consensus at 53.0.). With all eyes then on Fed governor Powell’s speech at the Chicago Fed conference tomorrow (23:55aest).

This all suggests staying cautious, and further de-risking seems the higher probability. Again, we have to consider the notion that when we have this level of uncertainty, we want answers and a circuit breaker to inspire, cover shorts and put on risk. Well, aside from incoming rate cuts from central banks, which, as detailed, is a question of ‘when’ not ‘if’, what will promote more stable growth and inflation? The answers don’t seem readily available.

Whats on the radar

AUDJPY – A trade I’ve been flagging for a while now and is working well as a hedge against slower global growth. A big move on Friday with price breaking below the consolidation range and I am happy to stay short, with a view that this could trend soon, which is where I will add. There are risks to holding AUD shorts of course, given tomorrows cut (from the RBA) is 100% priced, and the bank needs to be dovish enough to justify the three cuts priced into markets over the coming 12 months. 
USDJPY – Again, happy to stay short here, with the 108-handle likely to be in play soon, it seems. 
WTI crude – as detailed on Friday, the bid has come out of the oil market with price having dropped 21% from its April high – therefore the price is now in a technical bear market. Rallies are to be sold, in my opinion.

US500 – Price has gapped lower this morning, and the risk is we close this gap, but all signs suggest this index trades lower. Price has closed through the 200-day MA and 55-week MA (2772), but flip to the monthly, and we saw a bearish outside monthly reversal at the all-time high. It all suggests we head towards 2650. 
Chris Weston, Head of Research at Pepperstone

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Gold Playbook – Gold will shine in EURs not USDs

All the while we see $11.1t of global bonds now commanding a negative yield – the highest since January 2015 – and we could argue gold should be nicely above $1300 here.

As we can see though, gold has diverged from its link with both the pool of bonds that have a negative yield (red) and ‘real’ US 5-year Treasuries (green). At a simplistic level the idea, is that when the yield on offer in fixed income is falling sufficiently and going negative (reach out if you want more information on negative yields), then the fact gold has no yield is ironically yield in itself. Perhaps this is where we get this so-called ‘store of value’ mantra.

If we look at gold priced in USDs (XAUUSD), we can see strong support into $1270/66 and one suspects that if this gives way then we’d be looking for a move into $1250 to $1243. The series of lower highs seen since February suggests a cautious stance is warranted. That said, while I am neutral on price now, a close through $1287 would put a test of the top Bollinger band ($1297) in play and then the last major swing high of $1303.

Price is currently oscillating either side of the 20-day MA and is searching for direction. And, with the 14-day RSI sitting mid-range, the higher probability trade in the short-term here is to work orders into the wings of the Bollinger bands at $1297 to $1269 respectively in the short-term.

While we can look at potential levels that could accelerate price moves, or that we can identify as possible bid/supply zones. However, if we look at golds one-month implied vol, we can see this at a near record low and this shows that traders are simply not expecting big moves in price (in either direction). So, the market is portraying that this steady grind should continue, an important consideration for position sizing.

I talk about the technical set-up being neutral (at this juncture), but, in fact, we can see from gold futures positioning (taken from the weekly Commitment of Traders report), that managed money is about as neutral as we will see on gold and running a flat net exposure. It feels that the technicals on USD-denominated gold effectively marry perfectly with futures positioning.

One interesting chart we see working is the gold/silver ratio, which now sits at the highest levels in 26 years. One questions how much juice is left in this trade, but being long gold and short of silver as a pairs trade has worked incredibly well over any timeframe. Clearly, it’s the silver side of the equation showing weakness, with spot -7% YTD, while gold is unchanged YTD.

So, if the bond market is failing to promote a spark in gold, what is holding it back? Well, I would firstly focus on financial market volatility, which if we look at equity volatility (vol) we see implied vol (I’ve looked at the VIX index) in the S&P 500 still below 18%, which hardly shows expectations of big range expansion in price. It feels for gold to really motor on then vols really need to pick up here. We can also see implied vol in G10 FX markets sitting at 6.79% (I am looking at the JP Morgan implied volatility FX index), which is a reasonable discount to the one-year average of 7.92%.

When all DM central banks are moving policy in alignment then vols are suppressed. What we really need to see is emerging central bank divergence and clear differences in policy settings. This would cause higher vol and put a better bid in gold.

The USD effects

Another consideration has to be the USD impact. As we can see from the daily chart of the USD index (USDX) price looks to be breaking out into new highs. Consider that the EUR has a 57% weight on this basket of currencies traded against the USD, so flip the chart to EURUSD and we see price trading into the lower limits of tis 1.1260 to 1.1110 range it’s held since late April. A close through 1.1110 will only limit golds (in USD) appreciation and this takes on new consideration ahead of the ECB meeting on 6 June.

If this bullish run in the USD continues, why not look at trading gold denominated in AUD (XAUAUD) or EUR (XAUEUR). At Pepperstone we let you take the USD out of the equation.

Gold in AUD terms – Patience is required here, but it is on the watch list.  A firm close through A$1880 and the prospect of a move into and above A$1900 looks elevated.

Gold in EUR terms – Again, the preference is to let price guide and force a trade and through the double top at EUR1162 and this should trend higher. If we expect the ECB meeting to be dovish and a EUR negative, pushing EURUSD through 1.1110, then EUR gold should be on the watchlist.

Chris Weston, Head of Research at Pepperstone

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All in on the Fixed Income Juggernaut

A -5.2 read (vs expectations of +6.2) in the Dallas Fed manufacturing read was also in play, suggesting downside risks for next Tuesday’s US national manufacturing ISM read, at a time when expectations are for a slight rebound in the index to 53.3. As mentioned yesterday, we wait in anticipation upon the details of China’s manufacturing PMI read (Friday at 11 am), and should that come in below 49.9 then I’d expect volatility to rise further from here.

Reaction from Asia based traders

The main news flow though has centred on trade tensions, although most of the headlines were known yesterday when we saw a surprisingly upbeat equity session. So, the fact we saw the S&P 500 closing -0.8%, with 87% stocks lower on the session, on volumes some 23% above the 30-day average, has seen Asia coming off fairly hard today, with the ASX 200 -0.8%, Nikkei 225 -1.4% and Hang Seng -0.6%. That said, watch China today as the PBoC has just announced it is injecting RMB250b of liquidity in China’s money markets (most since January 2017), so this may aid sentiment.

Sell USDJPY through 109

My focus has been on the S&P 500, as well as the Phili semiconductor index (SOX, closed 0.9%), and on the former, whether we see a break of the 2890-2800 range the index has held since 8 May break. Well, we are testing the lower limits of that now, and as expected we are seeing equity vol rise, with the VIX index now at 17.5%. It feels as though we could S&P 500 implied volatility into 20% on a break of 2800, and this will see a further rotation out of cyclical names and into defensive sectors and assets. It will likely resonate in FX markets, with short USDJPY one of my preferred plays here given the correlation with S&P 500 futures. If USDJPY moves through support seen between 109.25 to 109, then I’d be holding for 108 and below.

Orange – S&P 500 futures, white – USDJPY, Source: Bloomberg

I’m still holding AUDJPY shorts, although there is solid support between 75.50 and 75.25, so a daily close through here and the bear trend continues in earnest, even if Aussie swaps are already pricing in a sizeable 70bp of cuts, or nearly three cuts, in the coming 12 months. So, given the markets current pricing, the RBA cash rate is expected to be closer to 0.75% this time next year. It’s interesting that the Aussie 10yr Treasury sits -3 basis points lower on the day with a yield of 1.501%, and a whisker away from a discount to the current RBA cash setting of 1.50% – a fate we haven’t seen since January 2015.

Top pane – Aussie 10yr – RBA cash rate, lower pane – RBA cash rate

The bottom line: With the rate cut priced at a 100% probability and Aussie bond yields at a discount (to the cash rate) out to 10-year, if the RBA doesn’t ease next week then the markets are going to absolutely punish Aussie assets. The fact, then, AUDUSD 1-week implied volatility sits at 6.8125%, and a discount to the 30-day average of 7.55%, suggests the market is incredibly confident and comfortable at the prospect of a cut next week, and rightly so, it’s a done deal.

Global growth concerns at the heart of market moves

Global growth concerns are compelling inflows into fixed income, and while we can focus on Australia, let’s not forget the 10yr German bund now sits at -16bp, and the lowest since 2016. This notion of negative yields isn’t new though, and we can see the total value of all outstanding debt rising to a massive $10.828t and the highest since early 2015. In the US, we see the US10yr Treasury closing -5bp into 2.26%, and it’s always good to look this market on the weekly chart, where we see just a textbook downtrend and what is effectively a rampant bull market.

The total value of all outstanding bond with a negative yield – $10.828t

The outperformance from the long-end of the US Treasury curve has resulted in a further flattening, with much talk about the fact US 10yr Treasuries yield 8bp less than 3-month Treasuries. We can also look at the fact US5s command a lower yield than US 2s, and this inversion has been a solid precursor for future Fed easing cycles, which is what we see in the Bloomberg chart. Where aside from a period in 1995, we have seen inversion between 2s and 5s resulting in the Fed cutting rates, albeit with a lag effect. The fact we see 28.5bp of cuts now priced into US interest rate market by year-end backs this point, and in the eyes of the market it’s a matter of ‘when’ and not ‘if’.

There are so many worrying signals flying around in fixed income, and one questions how much lower yields can go if we get a poor China PMI report on Friday, and a US core PCE below 1.50%.

All eyes on inflation expectations

I flagged the idea of watching broad financial conditions yesterday, but we know the Fed (and all central banks really) are not just looking at inflation, but inflation expectations. We can measure and trade these in the bond market, through instruments known as ‘breakevens’, and if we focus on five-year expectations, we can inflation expectation’s heading lower, and this has to be a concern. In the US, we have seen this falling to 1.85% from 2.12% in April and eyeing the year-to-date lower of 1.77%.  A break here and I would expect the Fed’s language to shift markedly, especially if it marries with a broad tightening of financial conditions.

white – US 5-year inflation expectations, yellow – European 5yr expectations

The article was written by Chris Weston, Head of Research at Pepperstone

Daily Fix – Let Financial Conditions be Our Guide

Asian equities are seeing small buying, with the ASX 200 +0.6%, the Nikkei and Hang Sen +0.4% respectively. A 2% gain in Brent crude and an out-of-control iron ore futures price isn’t hurting, with energy and material stocks putting in points.

China is looking constructive at this stage, with the CSI 300 +1%, and if we are to focus on the bullish variables, the fact that the margin buying ratio (equity purchases on margin divided by overall stocks turnover) increased 2.86ppt yesterday to 14.63% suggests the bulls are getting a better say here.

We also saw small buying in European equities with trade again the focal point with Trump detailing that the US had made “great progress” in trade talks with Japan.

At the same time tariffs on Chinese goods “could go up very, very substantially, very easily” and that the “US isn’t ready for a trade deal”. On the other side of the ledger, the Global Times came out with an editorial with “The US wants to rob China of not only its money but also it’s future”.

The trade theme isn’t going anywhere fast, however, despite these headlines, markets still seem quite calm about trade proceedings. In fact, if we take a more holistic approach and look at broad financial conditions, and if we take the US markets as an example, it feels as though we are in a holding pattern, waiting for a move. If we know the Federal Reserve focuses on the various financial condition’s indices, then its important to us too, and until these break down we are unlikely to see much change in communication from the Fed.

The daily chart of the S&P 500 (see below) continues to guide, with price trapped in a 2890 to 2800 range, and with implied volatility (VIX index) at 16%, a break out of this range (in either direction) would have implications for global markets and potentially set off a new trend. Let price guide.

It’s not just the S&P 500 that influences financial conditions, but inputs such as implied volatility, credit spreads, funding and money market rates, and if things get too tight, the Fed will move to meet the market who already see 26.5bp of cuts priced this year – this is what we are all waiting for.

As we can see from the Goldman Sachs financial condition index, conditions have tightened a touch in the past few weeks, but we are still far away from where we were in December, which resulted in the Fed’s now infamous pivot and change to a far more flexible and realistic stance.

(Source: Bloomberg)
(Source: Bloomberg)

The trade seems clear; markets are positioned for the fallout from trade, we have hedged portfolios through long JPY and CHF, specifically against the AUD, KRW and TWD. While traders are set in rates, and USTs, where we see aggressive rate cuts priced in most DM economies. In equities, the trade has been to short Semi’s, with the Phili Semi index (SOX) falling near 20% since April and following what is arguably getting more focus (even if it is lagged data); a collapse in global and US semiconductor sales.

Green – semiconductor sales up to March, Red – MSCI world index, Blue – Phili Semi index

In FX, we see stability return to USDCNH, and indeed the jawboning from Chinese authorities seems to be paying off. We can look at USDCNH 1-month risk reversals and understand the relative demand for put vols are increasing of late (over calls), and this tells the story of a market which sees a less one-way move ahead. A break of 6.9000 would be interesting though, possibly aiding AUD upside. While US-China talks dominate, an event risk worth highlighting is China’s May manufacturing PMI on Friday (11 am). The market expects the index to head to 49.9, where anything below 50.0 shows a contraction. A weak number could see vols and uncertainty pick up a touch.

Orange – USDCNH, white – USDCNH 1-month risk reversals

Focusing on the AUD, and in the absence of much US participation, we see AUDUSD finding offers into 0.6940, pulling back a touch to 0.6920 (at the time of writing). The 14-day RSI has moved back to 50.0, and it feels as though we chop around until we see the China data, and I see a range of 0.6955 to .6895 in the session ahead, which is in-line with the pricing of overnight implied vol.

On the USD side, eyes this week fall on Fed vice chair Richard Clarida, who speaks on Friday morning at 2 am at the Economic Club in New York, and for markets searching for catalysts, he may give us new clues on what could cause the Fed to ease, something we failed to see in the recent FOMC minutes.

Also keep in mind we get US (April) core PCE (Personal Consumption Expenditure) just over 10 hours later and with the prior read coming in at a weak 1.55%, and the market expecting a read of 1.6% this time around, if we get a number below 1.50% then this could see the market really question the idea that inflation is actually ‘transitory’. A hot number will see traders questioning the 26.5bp of cuts priced this year.

Elsewhere, GBP moves look heavy, and while cable printed a higher high, with price trading into 1.2753, sellers resulted in price retracing over 60% of Monday’s range. It seems the market is happy to sell strength, and as detailed yesterday, most paths lead to a lower GBP here. Of course, if we can see Labour firmly realign themselves as the major Remain party and push for a second referendum then that would be one path for a stronger GBP, as the EU would clearly be keen to grant an extension for this to play out, as long as ‘no Brexit’ was on the ballot paper. It is looking more and more likely that we are staring at either a second referendum or a general election, although we can’t rule out the UK leaving in October without a deal under a new Tory leader. I like GBP vols here.

EURUSD was thrown around overnight as Italy took centre took centre stage again. While traders digested politics and the notion that Lega amassed 34% of the Italian votes (in the EU parliamentary elections), while coalition partner M5S saw its share drop to 17%, the market didn’t seem too uncomfortable with this. The concern being, if Lega led by Matteo Salvini, were to capitalise on this strength and call a snap election later this year it could give them a stronger anti-EU mandate. Bloomberg quoting “sources” also claimed the EU Commission could slap Italy with a EUR4b fine (or 0.2% of GDP) for not acting to reduce 2018 debt levels. If Italian politics is going to be a driver of EUR vol, then we revert to the Italian-German 10-year spread. Politics aside, it’s hard to be long EURs ahead of the 6 June ECB meeting, where Draghi cannot be anything but dovish given EUR 5yr inflation expectations.