Dollar Hardly Profits from Deterioration in Risk Sentiment

Markets

There was no really dominant theme to guide broader trading yesterday. Even as the US shutdown has halted it still will take time for markets to be able to rely on (timely & accurate) official data. In this respect the time of flying blind isn’t really over yet. On FI markets, yield changes in US Treasuries and EMU/German bonds were limited. US yields changed between +0.4 bps (2-y) and -1.2% bps (30-y). With less than 50% of a December rate cut discounted and comments from Fed members still showing elevated disagreement, there is little incentive for markets to push in either direction. EMU/German yields also changed by less than 1 bp across the curve. The EC autumn economic forecasts expecting EMU economic growth at 1.3%-1.2%-1.4% over 2025-2026-2027 and inflation holding near 2% only confirmed that there is little reason to expect additional ECB easing in the foreseeable future. The 2-y EMU swap yield at 2.20% closed at the highest level since end March. The 10-y swap at 2.75% even nears the mid-March top. At least for now, the adagio ‘no news, is good news’ for risk sentiment doesn’t work anymore. Both US and EMU equity indices struggle to avoid a break below first relevant support levels. For the S&P 500 a break below 6631/6550 and of the EuroStoxx a break below 5554/5487, would signal some cracks in the broader picture. Will tomorrow’s Nvidia results be able to bring some clarity? At least of now, low visibility on the pace on further Fed easing probably also prevents the dollar from fully taking up its safe haven role. DXY yesterday regained some ground (close 99.59) but firmly holds with recent short-term range (99.00/100.36). Similar picture for EUR/USD (close 1.1592). The yen still underperformed (USD/JPY 155) as markets ponder the impact of a stimulative policy, both for the currency as for Japanese bond markets, with ultra-long yields (30-, 40- and especially 20-y) nearing/touching record levels. Last week’s sell-off in UK Gilts eased yesterday ‘eased’, and sterling temporarily settled just north of the 0.88 barrier. Even so, with the budget debate still ongoing and risk sentiment fragile, sterling is likely to stay in the defensive.

Sentiment in Asia remains outright risk-off this morning (e.g. Nikkei -3.25%). At the same time, a further rise in Japanese LT yields (e.g. 40-y at 3.75%; +6.5 bps and testing the May top, 20-y at record 2.8%) illustrates that the theme of fiscal sustainability remains at work. To some extent, it probably also prevents (core) bonds to fully play any safe haven role. We continue to keep a close eye at the ultra-long end of the curve as a further rise in yields even might be an additional negative for broader risk sentiment. For now, the dollar hardly profits from the deterioration in risk sentiment, probably also as the uncertainty on the valuation especially in US tech stocks is one of the sources of overall market uncertainty. For now, the likes of EUR/USD might hold to recent ranges (1.15-1.17). Or will the weekly ADP payrolls data unlock this stalemate?

News & Views

A group of lawmakers in Japan’s ruling Liberal Democratic Party, oddly called “the Responsible and Expansionary Fiscal Policy Caucus”, pushed prime minister Takaichi to come up with an extra budget that is significantly larger than what has been floated recently. Local media over the weekend reported that Takaichi’s promised package could total around JPY 17tn, or +/- 3% of GDP. The Caucus, however, argues its size should be way higher, to the tune of JPY 25tn. That would be the biggest in 20 years, excluding the pandemic period between 2020-2022. The group in its proposal shrugged off any of the market concerns about fiscal sustainability or rising bond yields, calling them “excessive and unsupported by data or global consensus”. The long end of the Japanese yield curve in any case again significantly underperforms, with yields at the 40-yr bucket adding 7 bps and now trading less than 2 bps away from its May record high.

PM Carney of Canadia narrowly won an important vote on the budget yesterday. His proposal secured the slimmest of majorities in a 170-168 vote after a handful of opposition members abstained and the Green Party leader voted in favour. Carney’s Liberal Party fell short of winning a majority of the 343 seats in the House of Commons in April’s election. Had the vote failed, Canada was headed for its second election in less than a year. The budget can now proceed and more votes are to come. But Monday’s result indicates that it will eventually be approved. Carney’s proposal foresees an extra C$ 167.3bn in total deficits over five years and seeks amongst others to cushion the blow from US tariffs, raise defense spending and fund housing programs.