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At the epi-centre of markets, we find Mr Trump dictating capital flows and seemingly going on a war-path pointing fingers at multiple parties. That said, what we have heard from the US president overnight is not necessarily new information.
On the session, one clear talking point was the attention Trump gave to Fed Chair Jerome Powell in media reports, suggesting he would keep critiquing the Fed if rates were to going to continue heading up, and that ‘I should be given some help by the Fed’. The comments seem to have resonated with interest rate traders and we can see a slight re-pricing through the Eurodollar futures curve, with the difference between the December 2018 and December 2020 contracts falling three basis points to 32.5bp – suggesting once we get the 25-basis point (bp) hike in September, the market then expects one full rate hike and a 30% chance of a second through this extensive period.
Trump, of course, will be happy at the reaction, not just in the rates market but in the USD and equities too, where consumer stocks outperformed, with the S&P 500 closing up 0.2% and high yield credit largely unchanged. As a Segway, look for Asia to fire up fairly nicely here with the ASX 200 likely to open shortly on the front foot, although there has been some focus on the political backdrop with Peter Dutton failing to contest Malcolm Turnbull for the party leadership.
China is expected to build on the 1.2% gain seen in the CSI 300 yesterday.
We can look at relative interest rate differentials as a critical driver of FX markets and look at what is priced into say the European rates curve (Euribor) relative to Eurodollar futures. Here, we can see a strong correlation with EURUSD, which makes sense, and one asks how much further the market can price out Fed rate hike expectations, or conversely price in ECB hikes.
(Orange line – EURUSD, Blue – interest rate differential between EU and US rate expectations between Dec ’18-’20)
(source: Bloomberg)
EURUSD has pushed into the 1.15 handle and, as mentioned yesterday, the May/June double bottom comes in at $1.1510, which, should we see a break, put $1.1550, although I’d expect better sellers to emerge here.  Given these moves, the USD index has now seen four days of losses, which to put into perspective we haven’t seen five days of losses in 2018. The fact the USD has closed through trend support at 95.71 should be noted too and for the second day, we have seen all G10 currencies finding buyers against the greenback on the day.
It’s not just Jerome Powell and the Fed that Trump has taken aim at and we can see China, Europe, Turkey, Iran and even large tech have caught his attention. Still, his views on the Fed’s path to normalisation are really the ones which have caught trader’s attention, although his influence on the USD should be short-lived and it would also be huge surprise if Jerome Powell fired back at the president in his speech at Jackson Hole this Friday.
One focal point in Powell’s speech is on the US yield curve. We heard Fed member Bostic speaking in Tennessee overnight, and his comments were interesting. Firstly, because the market is still trying to truly qualify his stance on policy, but secondly, because he has stoked the fire and the debate around the yield curve and how a flatter curve could affect their decision to raise rates further in the future.
Recall, that only in June Fed researchers told us not to be concerned with a flatter curve. On the flip side, we can focus on the likes of Neel Kashkari (non-voter) who has been showing his concern about hiking into a flatter yield curve. However, with Bostic now also showing concern on the curve, it seems logical that traders will most prominently be focused on the Fed chairs views here this Friday, not to mention any rhetoric about the neutral rate.
The fact we have seen the long-end of the Treasury curve continues to find buyers and outperform is key, as a flatter curve is only going to drive capital out of the USD. There has been sizeable attention on the net short position in long-term US Treasury futures, and clearly, this is at risk, but we should then focus on the technical set-up in US 10’s, where a break of the neckline (currently 2.82%) of the defined head and shoulders pattern  should see this benchmark target 2.45%. Recall, the analyst’s consensus for the US 10-year treasury Q4 sits at 3.12%, and there are very few calling the 10-year into 2.45%. Should the 10-year Treasury head through the neckline then this could have huge implications for markets.
(top pane – US 10-year Treasury, lower pane – 3m/10yr Treasury curve)
(source: Bloomberg)
We can also adjust Treasury yields for inflation expectations and see both 5- and 10-year ‘real’ yields have dropped three basis points to 74bp respectively. This is another headwind for USD appreciation and in theory should be good for gold, not to mention emerging markets. Clearly, one to watch.
Published by Chris Weston, Head of Research, Pepperstone