The market has shifted into a defensive position as risks to the downside have increased. US Treasury yields came under pressure pushing 3m – 10Y spreads deeper into the inverted territory. USD was sold as St. Louis Fed President Bullard stated that a “downward policy rate adjustment may be warranted soon.” The market is now pricing in just under two Fed interest rates cuts in 2019 (significant shift from earlier expectations). Predictions for a protracted trade and rising Saudi oil production has sent crude prices lower. In the current macro environment, it is difficult to see any bright spots. With US President Trump calling host UK politician a “stone cold loser” and Duchess of Sussex “nasty” highlights how the general dialog has become toxic. This permeates the psychology of the markets, in our view. The downward trend in manufacturing sentiment continued in May, with China below the 50-expansion level and EU heading into contraction. The US ISM index has eroded meaningfully in recent months indicating only a slow expansion. However, the weak numbers do not take into account US 5% import tariff on Mexico. The risk that global growth fears will challenge overvalued asset prices indicates that the demand for safe-haven currencies will increase. JPY has the highest inverted correlation to VIX indicated that yen should be the risk-off trade of choice. CHF has been a broad gain in recent weeks as regional / EU specifics risk favors franc accumulation. The carrying cost of short USDJPY makes the trade painful, however, short EURJPY looks attractive in this environment. Should the ECB and BoJ keep their ultra-accommodating stance, deposit rates will be almost equal. EURJPY bounce today is likely a short-term relief rather than directional shift. But remember central banks actions is the dominate determinate of pricing, should the Fed indicated looser policy, US equity, and USD will rally.
By Peter Rosenstreich
