Fixed income is the centre of the financial world, and it’s hard to have a conversation without talking about the monster moves we saw in yesterday’s US trade.
It is a very rare occurrence to see US treasuries undergo such a huge move, that is without there being a critical piece of fundamental news that changes the game, but the technical breaks in both nominal and ‘real’ yields have resonated. US data was at the heart of the move, with a strong beat in the ADP payrolls report, while the services ISM grew at the fastest pace in 21 years and renewed calls that the US economy is ‘red hot’ are making their way around the floors. We can obviously marry that with a crude price that has shown huge resilience, despite a monster 7.9m build in weekly inventories, and again talk of $100 a barrel in crude has been a talking point. A narrowing of the Italy/German yield spread has also given the selling a further tailwind.
(Source: Bloomberg)
The USD has been the natural beneficiary of the moves in bonds, and while economists point to the growing US twin deficit as the central thesis for why the greenback should decline over time. For the here and now, we are fully re-focused on divergence at both a monetary policy and an economic level, and these two considerations have given fresh tailwinds to the USD. While the recent manufacturing ISM report was hardly inspiring, there is little doubt that on the whole the US data flow is doing very well and this was acknowledged by governor Powell himself overnight. Throw in comments that are aligned with recent rhetoric from Lael Brainard, that the Fed is prepared to take the fed funds rate above the neutral rate, and it’s not hard to see such a powerful sell-off in both rates and bonds.
The question here is just how much good-will is now priced into the USD ahead of Friday’s payrolls and what could be the ramification of a miss in the data relative to consensus. Having closed yesterday’s session up 0.3%, Asia has bid up the USD for the seventh day and as things stand the USD index is sitting just north of 96.0, although FX traders are not doing a whole lot and waiting for the European/US session before ramping up trading.
Asian emerging markets (EM) are predictably not liking this toxic mix of higher ‘real’ (or inflation-adjusted) rates and USD upside, and while Italy garnered the front pages of late, it seems EM is back in vogue with the KRW, IDR and THB all around 0.8% lower. Both the AUD and NZD, which seem to have resorted back to the status of a G10 proxy of EM, are finding sellers easy to come by and extending the decent sell-off we saw through European and US trade yesterday.
Indeed, flows to add to long USDCNH have pushed the pair above 6.9000, setting up a test of the 15 August highs of 6.9586 and in-turn providing further fodder to AUD bears, of which there are many. I had been expecting some short covering in AUDUSD of late, but every rally has been savaged, and all eyes fall on the 11 September pivot low of $0.7085. A daily close through here opens up a move into 70c, which isn’t just a round number, but the two-standard-deviation of the line of best fit of the bearish channel seen since January (see Bloomberg chart below)

EM is the buzzword though, and it seems that if Friday’s US average hourly earnings come out above 2.8% and we see the underemployment (U6) rate head lower than 7.4%, then EM volatility could ramp right up again. Tactically, it feels as though the market goes into the payrolls report with sky-high expectations and long of USDs and rightly so. The employment sub-component of the services ISM was sensational, while jobless claims and ADP private payrolls provide us with the belief that net job creation on the month will be above 200,000. So, with the market positioned as such, the question of how confident we should be holding USD longs into Friday’s payrolls is one being asked.
It certainly feels as though if we do get a miss, then the reaction to buy US treasuries and sell USDs could be punchy.
Another consideration is how higher bonds yield impact equity markets because at this stage it is USD that is benefiting and the late session sell-off in the S&P 500 could be very telling. As mentioned yesterday S&P 500 futures are my guide, and ideally, I want to see a move through 2947 before turning bullish, while the price is just cracking the June uptrend and a close through 2907.5 would likely see implied volatility ramp up.
If we look around Asia, the Hang Seng has been sold 1.7% and is eyeing a re-test of the September lows of 26,219. As a Segway, overlap AUDUSD and the Hang Seng and see the correlation, it’s fairly impressive. 
(Orange – AUDUSD, bars – Hang Seng, lower pane – CNHUSD)
(Source: Bloomberg)
The Nikkei 225 has seen some of the heat coming out of the index, with price lower by 0.2%, but coming off earlier lows. That said, most of the attention has been on the Japanese bond market (JGB), with the 10-year JGB pushing to 16bp, into the highest levels since January 2016, and there have been few signs the BoJ have been in the market trying to limit the selling. Naturally, when the JGB 2s10s curve pushes up to 25bp (the highest since April 2017), the result will always be buying of Japanese financials, and we can see the space up 1.8% today – clearly the BoJ are enthused by this, as they have talked up the idea of a more profitable banking sector.
The ASX 200 has again bucked the trend here, with a 0.5% gain, with investors buying financials and materials, with both sectors putting in 22-index points between them.
So, a big session ahead and all eyes on whether the selling in fixed income markets continues, although the calendar is confined to US factory orders and durable goods and these data points are unlikely to move the dial too greatly, and it’s the payrolls report that gets all the attention.
Published by Chris Weston, Head of Research, Pepperstone