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Today's news headlines:

  • ‘Dollar gains as growth woes fuel flight to safety: inside G-10’. Irrespective of causality, a broad-based move out of equities into sovereign bonds appears to be taking place. Deeper inversion of the US Treasury yield curve—far dated bonds return less than shorter-dated bonds—has been highlighted as a particularly acute symptom of this phenomenon, which can be a warning of economic decline. (Bloomberg)
  • ‘Stock markets fall amid US-China trade tensions’. After a moderate equity sell-off over the past two weeks, the US-China dispute continues to cast dark clouds over investor sentiment, leading to more downward pressure on global equities. At its heart, little has changed, each side has more clearly defined their negotiation position, but many fear that it’s a deeper entrenchment into hostile foxholes. (Financial Times)

US will scrutinise China currency practices

Yesterday, the US Treasury Department delivered its semi-annual foreign exchange report in which no country was named as a manipulator. The number of watchlist countries increased to nine after Treasury Secretary Steven Mnuchin lowered the threshold for qualification, enabling the US to scrutinise more than 80% of goods trade. Usually, countries would have to meet two of three criteria to be included on the list, China only met one of the criteria but was still included due to its large trade surplus with the US. Currency policy has been used as an important tool for President Trump in trade deals struck with Mexico, Canada, and South Korea, and is expected to be a key part of any agreement with China. The fact that China wasn’t labelled a currency manipulator indicates that the Trump administration wants to avoid escalating matters further before the G20 meeting. However, the report does cite specific concerns with the undervaluation of the RMB relative to the Dollar.

Bottom line: Continuing the trade war theme, the US is careful to avoid ‘poking the bear’ any further at this time. The cynical eye sees a deal being struck just in time to be used as ammunition in the Trump 2020 campaign.

Bond rally on trade malaise

Surging bond prices reflect investors’ concern over slowing global growth and trade tensions between the world’s two largest economies. Historically, the US Treasury yield curve has been used as a key indicator of investors’ expectations for future interest rates, which again are based on the pace of global growth. So far this year we have seen bond markets rally pushing yields lower across the world, most notably in the US. One metric for the scope of bond price inconsistency is the yield spread, which compares borrowing costs between different maturities and can be an indication of market expectations of future rates. Overnight the three-month – 10-year spread fell to its lowest level since 2007, Australia and New Zealand yields of similar maturities reached record lows, and Japanese yields hit three-year lows of minus 0.1%. This shows strong market demand for sovereign bonds but almost certainly also highlights expectations of lower rates, potentially to support flagging growth. At present, markets are pricing in three 25bps rate cuts from the Federal Reserve by the end of next year. In light of this dynamic, investors will be listening carefully to central banks’ responses over the coming weeks.

Bottom line: Investors push bond yields lower across the world in a flight to safety as global growth concerns persist. The inversion of the US yield curve may provide a deeper sense of worry, particularly if it remains in this state.

GBP/USD

The trade-weighted Pound Index has held steady since the start of EU elections on the 23rd where it reached a four-month low. The Dollar, on the other hand, is trading up towards six-month highs, which were last seen in the equity sell-off in Q4 of 2018. With each currency at respective extremes of their ranges, the impetus required for further movement is high. With a data-light calendar this week, political news flow will be the key determinant for change.

EUR/USD

Like the Pound, the trade-weighted Euro is holding steady, while the US Dollar is rallying towards highs. This suggests the pair is susceptible to some downside but again, the limited data releases make politics the main event.

GBP/EUR

Belying a tumultuous political calendar, the Euro has held a very steady consolidation course for the entirety of May, trading between 50- and 100-day moving averages on a trade-weighted basis. The likely bottoming of the Pound suggests short-term support for the pair.