A Partner Betrayed

Perhaps today’s story is trade
Where NAFTA fans now are dismayed
Meanwhile ‘cross the pond
The EU has donned
The cloak of a partner betrayed

Some days, there is very little to discuss regarding the big picture, and even less to discuss regarding specific issues. Today appears to be one of those days, so I will be brief as I touch on the few things that seem to matter.

The Asia session revealed only two new data points of note, Australian jobs and Japanese outbound investment. The former showed an increase in full-time jobs of 32.7K that was larger than expected, and even though the Unemployment Rate rose to 5.6%, up 0.1%, the market looked at the jobs data and pushed the Aussie dollar up 0.5% at its peak, although it has since drifted back a smidge. However, it remains the best performing G10 currency vs. the dollar this morning. Meanwhile, Japanese investors increased the pace of foreign bond investment substantially, buying ¥827 billion last week as US yields are obviously becoming too attractive to ignore. The yen fell 0.25% on the news, trading back to its lowest levels since late January. One cannot be surprised at this given the BOJ’s ongoing efforts at yield curve control as they maintain 10-year JGB yields near 0.0%. When looking at that in comparison to US 10-year’s at 3.10%, the trade is pretty straightforward. This is especially true if investors are less concerned that the dollar is going to fall sharply, which of late seems to be the case.

Moving on to Europe, there was a distinct lack of data released and the only noteworthy comments came in the wake of an EU meeting in Sofia, Bulgaria, where the leadership coalesced around a position on trade. Essentially they said they were happy to negotiate a free trade deal, but would not do so with the threat of US steel and aluminum sanctions hanging over their head. In fact, they have a slate of retaliatory tariffs prepared to go in the event that the US tariffs go into effect next month. Interestingly, the euro, which had edged higher earlier in the session, fell after the news. Now it is possible that there was some other rationale for the euro’s decline, but I have not been able to find one. The single currency’s earlier strength had been predicated on the latest news from Italy, where yesterday’s story about seeking a write-off of €250 billion of debt has been walked back to where the Italians now want to be able to simply exclude debt held by the ECB from debt/GDP calculations. I guess that would help them move back toward previously agreed targets, but it certainly wouldn’t change the reality.

And finally, the news from the Western Hemisphere consisted of a surprise ‘no change’ by the Brazilian central bank, as they left the SELIC rate at 6.50% and appear to have abruptly come to the end of their easing cycle. Given the fact that the BRL has fallen 10% in the past month, their lack of a cut ought not be that surprising. And while Argentina continues to be a disaster, with no IMF agreement yet complete, more attention was paid to Mexico and Canada, where it appears that any completion of a new NAFTA deal will not be happening soon. Today marks the deadline discussed by House Speaker Ryan regarding the ability of the House to take up new legislation before the election season begins. And with the Mexican presidential election also looming in July, it seems like these talks will be on hold for a while. It is not clear to me if that means NAFTA will die, or if the status quo will remain until they resume. I am assuming the latter situation will prevail given the certain disruption a collapse of the agreement would bring to all three economies.

Taking all of this into account, markets are clearly undecided as to what to do next. Equity markets around the world are mixed with limited movement and the same is true with government bond markets and the dollar. In other words, traders are biding their time for the next potential catalyst. This morning’s US data brings only Initial Claims (exp 215K) and Philly Fed (21.0). Traders will be far more focused on the latter than the former as a strong number, like we saw from the Empire Manufacturing Survey, would likely serve as a reinforcement to the view that the Fed is not going to change its tack anytime soon. And given the Treasury market response to the Retail Sales and Empire data on Tuesday, a move that has not been retraced at all, I expect that a strong print could see another leg lower in Treasuries and another leg higher in the dollar. The narrative is slowly evolving from synchronous global growth to the US leading the way, and as data corroborates that view, the Treasury and dollar trends should extend further. I guess the real question is how long that can go on without equity markets coming under more renewed pressure. As to today, I expect the dollar to maintain its upward momentum barring an extremely weak Philly Fed print.

Good luck

3 thoughts on “A Partner Betrayed

  1. How are these foreign bond purchases hedged? I mean, ~2.5% on 2 year is wonderful compared to Japan, but if the yen moves more than 2.5% against the dollar, the entire investment goes into the red. Clearly, the yen can move that much in a month or less, and some sane people think by the end of 2019 the yen could be 100 or sub 100 again.

    • When the spread gets wide enough, and 250bps has historically been sufficient, they don’t hedge, especially if the dollar is not in free fall like now. You are correct that the spread can get eaten up quickly, but that is what history shows. And remember, with the US 10-year now trading at 3.11% as I type, that is over 300bps higher than the same JGB. they can’t resist that!

  2. Thanks. Perhaps over 10 years, they think there’s no need to hedge. And perhaps historically they’ve been right. I’m far less sanguine about that currently, however. 🙂 Thanks again!

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