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Market weekly – Corporate bonds: Resilience amid rising inflation (read or listen)

Thanks to central bank largesse, corporate bond markets weathered the depth of the Covid crisis well. Risks to credit markets today appear low with gradually improving fundamentals, neutral central bank policy and no major supply-demand imbalances. Listen

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Thanks to central bank largesse, corporate bond markets weathered the depth of the Covid crisis well. Risks to credit markets today appear low with gradually improving fundamentals, neutral central bank policy and no major supply-demand imbalances. Listen to the podcast with Victoria Whitehead, portfolio manager on the global credit team, or read the article below.

Are investors worried about the impact of rising interest rates and inflation expectations?

Inflation itself is not so much a problem for corporate bond markets nor are higher rates. Historically, these market have reacted more to the volatility associated with rate rises rather than the actual rate rises themselves, causing credit spreads to widen (see exhibit 1). Looking at correlations – of what moves credit markets and spreads – the main factor is economic growth. Rate rises for a positive reason – more growth – are positive for credit markets and we tend to see spreads narrowing.
Accordingly, as the macroeconomic situation improves on the back of lockdowns being wound down, economies improving and company earnings showing rising momentum, we have seen credit markets outperform other fixed income segments such as government bond markets substantially this year. We have had low credit spread volatility recently. We have two central bank meetings this month that could conceivably surprise: the ECB and the US Federal Reserve. However, on 10 June, the ECB signalled no change to its bond purchases. While it is possible that this week the Fed may ‘think aloud’ about tapering its asset purchases, we view the risks to credit markets as low. As a result, big moves in credit are unlikely: market positioning is shorter than at the time of previous tapers, and corporate cash buffers are higher.

How have corporate bond issuers been managing the Covid crisis?

They managed what initially was a very turbulent period relatively well. We were in uncharted territory. Bond spreads widened significantly last March, but it did not take long before central banks stepped in. The Fed started buying high-quality high-yield ‘crossover’ bonds to signal its support for corporates to the market. In Europe and the UK, central banks quickly stepped up their quantitative easing programmes. In addition, companies issued enormous amounts of debt to shore up their balance sheets and liquidity, in part as they worried about the impact of the crisis on their credit ratings. As a result, we have seen no major rise in rating downgrades. What downgrades there were involved companies that were on the cusp of falling into the high-yield category anyway and the pandemic just brought forward the rating action. Now, we are seeing issuers – the so-called rising stars – coming back into the investment-grade category on the back of the economic recovery. Corporate cash holdings remain at high levels with both liquidity ratios and coverage ratios close to all-time highs and notably stronger than at previous QE tapering points. This renders corporate defaults not only remote, but means supply pressures are low.

Are ESG considerations becoming more important in the credit market as well?

We have seen huge growth in the green bond market. To date, USD 180 billion worth has been issued globally – that is the equivalent of the full-year total in 2020 and also in 2019. Green bonds, which are being issued specifically to fund green projects, now make up 20% of the issuance. Encouragingly, they are coming onto the radar of central banks and their asset purchase programmes. Interest in this still relatively small segment in general and the huge inflows mean that green bonds are being priced at a slight premium to existing corporate bonds. That is attracting more issuers. Next to green bonds, there is growing interest in sustainability-linked bonds whose coupon is connected to specific indicators. The bond’s annual pay-out rises when the issuer fails to deliver on sustainability targets, creating an incentive for the issuer to meet environmental, social and governance (ESG) goals.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk. Writen by Victoria Whitehead. The post Market weekly – Corporate bonds: Resilience amid rising inflation (read or listen) appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.

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Twitter partners with AP and Reuters to address misinformation on its platform

Twitter announced today it’s partnering with news organizations The Associated Press (AP) and Reuters to expand its efforts focused on highlighting reliable news and information on its platform. Through the new agreements, Twitter’s Curation team…

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Twitter announced today it’s partnering with news organizations The Associated Press (AP) and Reuters to expand its efforts focused on highlighting reliable news and information on its platform. Through the new agreements, Twitter’s Curation team will be able to leverage the expertise of the partnered organizations to add more context to the news and trends that circulate across Twitter, as well as aid with the company’s use of public service announcements during high-visibility events, misinformation labels and more.

Currently, the Curation team works to add additional information to content that includes Top Trends and other news on Twitter’s Explore tab. The team is also involved with how certain search results are ranked, to ensure that content from high-quality searches appear at the top of search results when certain keywords or hashtags are searched for on Twitter.

The team may also be involved with the prompts that appear in the Explore tab on the Home Timeline related to major events, like public health emergencies (such as the pandemic) or other events, like elections. And they may help with the misinformation labels that appear on tweets that are allowed to remain visible on Twitter, but are labeled with informative context from authoritative sources. These include tweets that violate Twitter’s rules around manipulated media, election integrity, or COVID-19.

However, the team operates separately from Twitter’s Trust and Safety team, which determines when tweets violate Twitter’s guidelines and punitive action, like removal or bans, must be taken, Twitter confirmed that neither the AP nor Reuters will be involved in those sorts of enforcement decisions.

Image Credits: Twitter

By working more directly with AP and Reuters, who also partner with Facebook on fact checks, Twitter says it will be able to increase the speed and scale to which it’s able to add this additional information to tweets and elsewhere on its platform. In particular, that means in times where news is breaking and when facts are in dispute as a story emerges, Twitter’s own team will be able to quickly turn to these more trusted sources to improve how contextual information is added to the conversations taking place on Twitter.

This could also be useful in stopping misinformation from going viral, instead of waiting until after the fact to correct misleading tweets.

Twitter’s new crowdsourced fact-checking system Birdwatch will also leverage feedback from AP and Reuters to help determine the quality of information shared by Birdwatch participants.

The work will see the Curation team working with the news organizations not just to add context to stories and conversations, but also to help identify which stories need context added, Twitter told us. This added context could appear in many different places on Twitter, including on tweets, search, in Explore, and in curated selections, called Twitter Moments.

Twitter has often struggled with handling misinformation on its platform due its real-time nature and use by high-profile figures, who attempt to manipulate the truth for their own ends. To date, it has experimented with many features to slow or stop the spread of misinformation from disabling one-click retweets, to adding fact checks, to banning accounts, and more. Birdwatch is the latest effort to add context to tweets, but the system is a decentralized attempt at handling misinformation — not one that relies on trusted partners.

“AP has a long history of working closely with Twitter, along with other platforms, to expand the reach of factual journalism,” noted Tom Januszewski, vice president of Global Business Development at AP, in a statement about the new agreement. “This work is core to our mission. We are particularly excited about leveraging AP’s scale and speed to add context to online conversations, which can benefit from easy access to the facts,” he said.

“Trust, accuracy and impartiality are at the heart of what Reuters does every day, providing billions of people with the information they need to make smart decisions,” added Hazel Baker, the head of UGC Newsgathering at Reuters. “Those values also drive our commitment to stopping the spread of misinformation. We’re excited to partner with Twitter to leverage our deep global and local expertise to serve the public conversation with reliable information,” Baker said.

Initially, the collaborations will focus on English-language content on Twitter, but the company says it expects the work to grow over time to support more languages and timezones. We’re told that, during this initial phase, Twitter will evaluate new opportunities to onboard collaborators that can support additional languages.

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Mandatory COVID-19 vaccines on university campuses: An obvious solution or a problem?

Mandating vaccines risks turning a highly effective public health intervention into a contentious battleground — but it also may save lives.

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People line up outside the University of Toronto Mississauga campus for a COVID-19 vaccination clinic in Mississauga, Ont., in May. THE CANADIAN PRESS/Tijana Martin

In the United States, more than 600 institutions of higher education are requiring students to be vaccinated to return to campus this fall.

In Canada, Seneca College in Ontario is making vaccination mandatory for anyone attending campus. The University of Ottawa and others will require students living on campus to be vaccinated.

The University of Toronto has announced that in addition to requiring vaccination for students living in residence, it will “require students, faculty, staff and librarians who participate in activities that carry a higher risk of COVID-19 transmission to be vaccinated — and require all community members to self-declare their vaccination status” on an online platform. The university will use “anonymous, aggregate data on vaccination status, by campus,” to inform health and safety measures.

As September approaches, more post-secondary institutions will announce how they are managing COVID-19-related decisions.

We are two researchers with an interest in social and structural determinants of health who have been discussing and writing about the pandemic for the last 16 months.

We are involved in research about increasing COVID-19 knowledge and protective behaviours, and reducing pandemic stress among diverse LGBTQ+ and racialized people, and how harm-reduction programs for people who use drugs, and other addiction services and HIV prevention have changed in response to COVID-19.

While one of us is more supportive of mandatory vaccination on campuses — given voluminous evidence for COVID-19 vaccine safety and effectiveness — we are both nevertheless concerned about mandatory vaccination.

Avoid ‘battleground’ scenario

Our shared experience in social work, public health and ethics, including sexual health and HIV research, leads us to believe that mandating vaccination can risk turning a highly effective and routine public health intervention into a contentious battleground.

What otherwise might be an everyday health behaviour becomes increasingly loaded with stereotypes and assumptions about political motivations that can divide communities and marginalize individuals and their lived experiences.

Our research has shown us that reasons for engaging in practices often not condoned by health researchers and public health officials — such as sharing drug-using equipment — are often complex. And they often make sense in the context of people’s daily realities.

In the case of people living with HIV and people who use drugs, they often have sophisticated understandings and complex interactions with the health-care system. These communities often have innovative ideas about how to better meet the needs of their peers.

Mandatory in public sectors?

The great success of COVID-19 vaccines has led to calls to make them mandatory for health-care workers, for elementary and high-school staff, and in other public sectors.

We have personally followed public health requirements and have been vaccinated. We also recognize that vaccines have been the most impactful public health intervention of the last century. Vaccines save millions of lives every year.

But we also understand that while everyone who lacks antibodies to new coronavirus strains is at risk, the risks of infection, morbidity and mortality are influenced by broader socio-political and economic systems. In this way, COVID-19, like many other infectious diseases that concern public health experts, is rooted in inequity.

Social contexts, inequities

The COVID-19 pandemic has exacerbated pre-existing inequalities among racialized (“visible minority”) communities because of systemic racism in the health-care system, workplaces and living conditions.

Communities that experience the brunt of systemic racism and ongoing colonization, including in the health-care system, may be understandably reluctant or hesitant to get vaccinated. Black and Indigenous communities are navigating especially painful histories with harmful state-sponsored medical interventions.


Read more: Contrary to sensational reporting, Indigenous people aren't scared of a COVID-19 vaccine


Engaging these communities about vaccination requires cultural humility and respect.

Some people have medical reasons to not get vaccinated, such as allergies. Others may have religious reasons.

Then there are those considered “anti-vaxxers,” who reject vaccinations despite the evidence for their safety and efficacy.

In Canada, 70 per cent of the population has received at least one vaccine dose. Fifty-six per cent are fully vaccinated.

Students sit on the ground wearing face masks.
Students at Western University wait for a COVID-19 test on campus in London, Ont., in September 2020. THE CANADIAN PRESS/Geoff Robins

Risk of infection on campus

We share concerns about the risk of infection on campus and the importance of students getting vaccinated.

We also see rates of vaccination among young people ages 19 to 29 (69 per cent at least one dose, and 46 per cent fully vaccinated) in a positive light, considering they only became eligible recently, and with challenges in vaccine availability across Canada. Assuming single doses translate into fully vaccinated, we are left with questions about the remaining 31 per cent.

We consider two possible stances: mandatory vaccination and vaccine promotion.

Mandatory vaccination

In scenario one, post-secondary institutions view the nearly one-third unvaccinated as a threat — to the health and safety of themselves, other students, faculty and staff on campuses.

Putting aside the small subset unable to be vaccinated for medical or religious reasons, we are left with young persons who may be vaccine-hesitant. Or possibly anti-vaccination.

With the rapidly spreading Delta variant, the unvaccinated are at considerable risk for infection, and transmission to others. Clusters of infection increase risks of further mutations. Mandatory vaccinations might be necessary in this case. But is anything owed to the unvaccinated?

As many people return to workplaces, they want flexibility. Many universities adopted online learning platforms. If the unvaccinated are not permitted to attend in-person classes, they should be offered online alternatives.

Concerns that this will breach students’ privacy and open them up to shaming from instructors and classmates need to be addressed. Shaming people for health choices often backfires, sometimes intensifying their beliefs. We imagine online options being extended to all students during this transition period.

Vaccine promotion

Scenario two, vaccine promotion, considers the role our respective universities have played during the pandemic.

Both the University of Toronto and the University of Windsor host vaccine clinics and offer expert advice.

The University of Windsor (UW) does not require students to be vaccinated to return to campus at this time. It is partnering with UW Students’ Alliance and WE-Spark Health Institute to promote vaccination through peer-engagement and accessible information.

University of Windsor ‘Take a Jab’ campaign.

The approach means vaccination is made readily available, including on-campus clinics, and students are given time to make the decision about vaccination.

Incentive-based approaches are another option; they may lead some students “on the fence” to be vaccinated, but are unlikely to sway the truly hesitant.

Scenario two creates options for diverse students from across Canada, with different levels of vaccine access, to return to campus. This approach may be in keeping with the role of universities as bastions of critical debate. As COVID-19 continues to evolve, it will require ongoing vigilance.

Moving forward

In considering a highly consequential policy, we both support dialogue and community engagement, for which our research in Canada and globally has afforded ample evidence. An important way forward is for higher education leaders to consult with students, faculty and staff.

Universities have a short window to be proactive about the fall and winter semesters. They need to consider what a gentler return home for students might look like this time compared to 2020.

Significantly, they should also be considering how they can meaningfully support students, faculty and staff to return and recover from this exceptionally challenging period — one that is not yet over.

Peter A. Newman receives funding from the Canadian Instututes of Health Research, the Social Sciences and Humanities Research Council, the International Development Research Centre, and the Canada Foundation for Innovation.

Adrian Guta receives funding from the Canadian Institutes of Health Research, the Social Sciences and Humanities Research Council, and the University of Windsor Humanities Research Group.

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August Monthly

Fear that the spread of the Delta mutation of the covid would disrupt the global economy spurred the unwinding of risk-on positions. Interest rates fell, and the traditional funding currencies:  the US dollar, Swiss franc, and Japanese yen, strengthened..

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Fear that the spread of the Delta mutation of the covid would disrupt the global economy spurred the unwinding of risk-on positions. Interest rates fell, and the traditional funding currencies:  the US dollar, Swiss franc, and Japanese yen, strengthened most in July. While major US indices set new record highs, as did Europe's Dow Jones Stoxx 600, the MSCI Emerging Markets Equity Index fell 7%.

The preliminary July PMI reports were below expectations in the US, UK, and France.  Japan's composite PMI has been contracting since February 2020.  There has been some re-introduction of social restrictions in parts of Europe.  The UK's "Freedom Day" (July 19), when mask requirements and social restrictions were supposed to be dropped, turned into a caricature as the Prime Minister and Health Minister were in self-quarantine due to exposure, and the number of cases reached the highest level in 5-6 months. 

Given the large number of people in the world that remain unvaccinated, the challenge is that the virus will continue to mutate.  Moreover, even in high-income countries, where vaccines are readily available, and stockpiles exist,  a  substantial minority refuse to be inoculated. This is encouraging the use of more forceful incentives that deny the non-vaccinated access to some social activity in parts of the US and Europe.  In the US, the vaccines have been approved for emergency use only, and broader approval by the FDA could help ease some of the vaccine hesitancy.  Yet, rushing the process would be self-defeating.  An announcement still seems to be at least a couple of months away.  

In some countries, the surge in the virus even where not leading to hospitalizations and fatalities, maybe tempering activity and postponing more "normalization" like returning to offices.   The increase in the contagion has also prompted several companies to postpone plans to have employees return to offices. In other countries, like Australia, the virus and social restrictions are having a more dramatic economic impact.  Its preliminary July PMI crashed to 45.2 from 56.7, the lowest since last May.  Although many countries in East Asia seemed to do well with the initial wave, they have been hard hit by the new mutations.  For some, the recovery already had appeared to be in advanced stages.  

Floods in China, India, Germany, and Belgium add to the economic angst.    A freeze in Brazil sent coffee prices percolating higher.  Wildfires in Canada stopped the downside correction in lumber prices.  While rebuilding is stimulative, in the first instance, the natural disasters could be inflationary as transportation and distribution networks are impacted. 

The market reacted by pushing down nominal and real interest rates.  In late July, the US 10-year inflation-protected note yield (real rate) fell to a record low near minus 1.13%  Ten-year benchmark yields in the US, Europe, Australia, and China were at 4-5 month lows.  Expectations for rate hikes by high-income countries eased, and Beijing surprised investors by cutting reserve requirements by 50 bp (freed up ~$150 bln of liquidity).   

Still, other central banks, like Russia who hiked rates by 100 bp in late July, are pushing forward.  In Latin America, Brazil, Mexico, and Chile are likely candidates for rate hikes in August.  The market anticipates additional rates hikes from the Czech Republic and Hungary.  On the other hand, Turkey's central bank meets under much political pressure to cut rates.  Inflation is not cooperating, and it reached 17.5% in June,  a new two-year high.  Yet, the Turkish lira downside momentum eased, and this alone, in the face of a stronger dollar, meant it was the best performing emerging market currency last month, up about 3.0%.  Its 12% loss year-to-date still makes it the second-worst performing emerging market currency so far this year, behind the Argentine peso's nearly 13% decline.  

The Federal Reserve does not meet in August, but the Jackson Hole symposium (August 26-28) may offer a window into official thinking about the pace and composition of its bond purchases.  Under that scenario, a more formal statement would be provided at the end of the September FOMC meeting (September 21-22). Chair Powell has pledged to give ample notice about its plans to taper.  This means that the initial timing of the beginning of the tapering may be vague by necessity.  Many expect the Fed to begin reducing its bond purchases either later this year or early next year.  

The debt ceiling debate may add another wrinkle.  The debt ceiling waiver expired at the end of July.  There are several different ways that Treasury can buy time.  There are many moving parts, and it is hard to know exactly when Secretary Yellen would run out of maneuvers, but she probably has around two months.  In the past, the uncertainty was reflected in some T-bill sales.  Recall it was the debate over the debt ceiling (the government has already made the commitments or spent the funds and now has to pay for them) that prompted S&P to remove its AAA rating for the US in 2011. 

Meanwhile, Beijing is waging an internal battle to retain control in the technology and payments space.  It has also stepped up its antitrust actions and moved to make it more difficult for internet companies to have IPOs abroad. At the same time, the US threatens to de-list foreign (Chinese) companies if they refuse to allow US regulators to review their financial audits.  This is more than quitting before getting fired, though at the end of July the US announced that concerns over risk disclosures have prompt it to freeze applications for Chinese IPOs and the sale of other securities.  Its efforts to turn the private schools into non-for-profits are driven by Beijing's domestic considerations, but foreign investors--hedge funds, a couple US state pension funds, and provincial pensions in Canada appear to have been collateral damage.  Even the Monetary Authority of Singapore had exposure.

The jump in Chinese yields and the drop in equities that pushed the CSI 300 (an index of large companies listed on the Shanghai and Shenzhen exchanges) 21% below the February peak prompted some remedial measures by officials.  They succeeded in steadying the bonds and stock markets, and the yuan recovered from three-month lows as July wound down. However, both the disruption and the salve, the selling of industrial metals, coal, and oil from its strategic reserves, demonstrate the activist state that gives foreign investors reservations about increasing allocations to China.  To draw foreign capital, officials may be tempted to engineer or facility a strong recovery in shares and the yuan.  

Beijing is also meeting resistance from abroad.  Its aggressiveness in the region, including the aerial harassment of Taiwan and rejection of the Arbitration Tribunal at the Hague regarding the United Nations Convention on the Law of the Sea (that pushed back against Chinese claims in the South and East China Seas). Over the past few weeks, the situation has escalated. The UK announced it will station two naval vessels in the area.  Japan has promised to defend Taiwan should it be attacked by China.  The US has not been that unequivocal.   The EU has been emboldened.  Latvia became the first EU member to open a representative office of "Taiwan" instead of Taipei.  

Many wargame scenarios are premised on China attacking Taiwan, but this does not seem to be the most likely scenario. Top US military officials have testified before Congress that Beijing wants to have the ability to invade and hold Taiwan within six years based on comments from President Xi to the People's Liberation Army.  Yet, if China senses that the status of Taiwan is truly changing, it could move against the Pratas Island, which is off the east coast of China and the south tip of Taiwan.  It is closer to Hong Kong than Taiwan.  It is an uninhabited atoll with a garrison.  Taking this island would send a signal about its determination, with the costs and risks of invading Taiwan. It is true to the ancient Chinese idiom about killing a chicken scares the monkeys.  

Bannockburn's World Currency Index, a GDP-weighted basket of the top dozen economies, rose fractionally after falling 1% in June.  The two largest components after the dollar are the euro and yuan.  The former slipped by was virtually flat near $1.1860 and the latter softened by less than 0.1 %.  The yen, with about a 7.3% weighting in the basket, was the strongest, gaining about 1.25% against the US dollar.  Sterling was almost eked a 0.5% gain.  The Indian rupee slipped 0.1%, while Brazil's real was the weakest currency in the index, falling by about 4.6% in July.   

The BWCI rose by 6.5% in the last nine months of 2020 after falling by 3.2% in Q1 20 as the pandemic struck and structural dollar shorts and safe-haven flows favored the dollar.  It fell by 1.5% in Q1 21 as if correcting the previous advance.  It rose by 1.1% in Q1.  More so than bilateral exchange rates, the BWCI gives the impression that broadly speaking the dollar's losses from last year are being consolidated more than reversed. 

Dollar:  The greenback's two-month uptrend stalled in the second half of July, sending the momentum traders and late longs to the sidelines. The dollar's pullback had already begun before the FOMC meeting at which the Fed lent support to priors about a tapering announcement in the coming months.  The next opportunity is in late August. The weaker dollar tone that we expect to carry into August could create the conditions that make a short-covering bounce ahead of the Jackson Hole symposium more likely.  Some assistance,  like the moratorium on evictions, ended on July 31, and others, like the federal emergency unemployment compensation (where states continue to participate), are finishing in early September. Meanwhile, the Biden administration appears to see some of its infrastructure initiative approved in a bipartisan way and the other part through a reconciliation mechanism that it can do if there is unanimous support from the Senate Democrats.  Inflation remains elevated, and Treasury Secretary Yellen and Federal Reserve Chair Powell warned it may remain so for several more months but still expect the pressure to subside.  The price components of the PMI have eased in the last two reports. There appears to have been some normalization in used car inventories that also reduce the pressure emanating from the one item alone that has accounted for about a third of the monthly increase of late.  

Euro:   The leg lower that began in late May from around $1.2265 extended more than we had expected and did not find support until it approached $1.1750 in the second half of July.  A trough appears to have been forged, and the euro finished near the month's highs.  Technical indicators favor a further recovery in August.  Overcoming the band of resistance in the $1.1950-$1.2000 shift the focus back to the highs.  The low for longer stance by the ECB may be bullish for European stocks and bonds.  The Dow Jones Stoxx 600 reached new record highs in late July.   Bond prices are near their highest levels since February-March.  The IMF raised its 2021 growth forecast for the euro area to 4.6%from the 4.3% projection in April and 4.3% next year from 3.8%.  The economy seemed to be accelerating in Q3, but the contagion and new social restrictions may slow the momentum.  Inflation is elevated about the ECB's new symmetrical 2% inflation target, but it pre-emptively indicated it would resist the temptation of prematurely tightening financial conditions.  The debate at the ECB does not seem about near-term policy as much as the commitment and thresholds for future action.  

 

(July 30,  indicative closing prices, previous in parentheses)

 

Spot: $1.1870 ($1.1860)

Median Bloomberg One-month Forecast $1.1885 ($1.1950) 

One-month forward  $1.1880 ($1.1865)    One-month implied vol  5.3%  (5.6%)    

 

 

Japanese Yen: The correlation of the exchange rate with the 10-year US yield is at its highest level in a little more than a year (~0.65, 60-day rolling correlation at the level of differences).  The correlation of equities (S&P 500) and the exchange rate is in the unusual situation of being inverse since early this year.  In early July, it was the most inverse (~-0.34) in nine years but recovered to finish the month almost flat. The yen rose by about 1.4% in July, offsetting the June decline of the same magnitude. Its 5.7% loss year-to-date is the most among the major currencies and the second weakest in the region after the Thai Baht's nearly 9% loss. The JPY110.60-JPY110.70 represents a near-term cap. The JPY109.00 area should offer support, and a break would target JPY108.25-JPY108.50.   The extension of social restrictions in the face of rising covid cases is delaying the anticipated second-half recovery.  The preliminary composite PMI fell to a six-month low in July of 47.7.  

 

Spot: JPY109.85 (JPY111.10)      

Median Bloomberg One-month Forecast JPY109.85 (JPY110.70)     

One-month forward JPY109.80 (JPY111.05)    One-month implied vol  5.4% (5.4%)  

 

 

British Pound:  Sterling reversed lower after recording a three-year high on June 1 near $1.4250 and did not look back.  It dipped briefly below $1.38 for the first time since mid-April on the back of the hawkish Fed on June 16 to finish July at new highs for the month and above the downtrend line off the early June highs.   A convincing move back above $1.40 would confirm a low is in place and a resumption of the bull move, for which we target $1.4350-$1.4375 in Q4.  The postponement of the economy-wide re-opening until the middle of July, and a central bank looking past the uptick in CPI above the 2% medium-term target, weighed on sentiment.  The central bank will update its economic forecasts in August, and both growth and inflation projections likely will be raised. The furlough program ends in September, and it may take a few months for a clear picture of the labor market to emerge.  Nevertheless, the market has begun pricing in a rate hike for H1 22.  

  

Spot: $1.3905 ($1.3830)   

Median Bloomberg One-month Forecast $1.3930 ($1.3930) 

One-month forward $1.3910 ($1.3835)   One-month implied vol 6.6% (6.5%)

  

 

Canadian Dollar:  The Canadian dollar reached its best level in six years in early June (~$0.8333 or CAD1.20) but has trended lower amid profit-taking and the broad gains in the US dollar.  The usual drivers of the exchange rate:  risk appetites, commodities, and rate differentials were not helpful guides recently.  Canada has become among the most vaccinated countries, and the central bank was sufficiently confident in the economic outlook to continue to slow its bond purchases at the July meeting despite losing full-time positions each month in Q2. Speculators in the futures market have slashed the net long position from nearly 50k contracts (each CAD100k) to less than 13k contracts in late July.  The downside correction in the Canadian dollar appears to have largely run its course, and we anticipate a better August after the heavier performance in July.  Our initial target is around CAD1.2250-CAD1.2300.  

 

Spot: CAD1.2475 (CAD 1.2400) 

Median Bloomberg One-month Forecast  CAD1.2435 (CAD1.2325)

One-month forward CAD1.2480 (CAD1.2405)    One-month implied vol  6.8%  (6.5%) 

 

 

Australian Dollar:  Since peaking in late February slightly above $0.8000, the Australian dollar has trended lower and by in late July briefly dipped below $0.7300, posting a nearly 9% loss over the past five months. The 50-day moving average ~$0.7570) fell below the 200-day moving average (~$0.7600) for the first time since June 2020, illustrating the downtrend after the strong recovery from the low near $0.5500 when the pandemic first stuck.  The combination of a low vaccination rate and the highly contagious Delta variant forced new extended lockdowns for Sydney and social restrictions that have sapped the economy's strength.  It will likely slow the central bank's exit from the extraordinary emergency measures.  Indeed, the Reserve Bank of Australia is likely to boost its weekly bond-buying from A$5 bln to at least A$6 bln.  A convincing break of $0.7300 could open the door for a return toward $0.7000, but we suspect the five-month downtrend is over and anticipate a recovery toward $0.7550 over the next several weeks.  

 

Spot:  $0.7345 ($0.7495)       

Median Bloomberg One-Month Forecast $0.7425 ($0.7610)     

One-month forward  $0.7350 ($0.7500)     One-month implied vol 8.9  (8.5%)   

 

 

Mexican Peso:  The dollar chopped higher against the peso in July and reached a high near MXN20.25 on July 21. It trended lower and, in late July, fell below the seven-week trendline support near MXN19.90.  After finishing June less than 0.1% weaker, the greenback lost about 0.4% against the peso in July, which was the fifth consecutive month without a gain.  The other notable LATAM currencies were the weakest three emerging market currencies (Chilean peso ~-4.1%, Colombian peso ~-4%, and the Brazilian real ~-3.8%).  If the upper end of the dollar's range has held,  a break of MXN19.80 may warn a test on the lower end of the range (~MXN19.50-MXN19.60).  The 5.75% year-over-year CPI for the first half of July and the highest core inflation for early July in more than 20-years keep expectations for another rate hike intact when Banxico meets on August 12.  The market has another hike priced in for the September 30 meeting as well.  The dispute with the US over measuring domestic content for auto production under USMCA could undermine Mexico's role in the continental division of labor, but instead, producers in Mexico may choose to pay the WTO auto tariff standard of 2.5%.  The IMF's latest economic forecasts revised the projection for Mexican growth this year to 6.3% from the April projection of 5%.  

 

Spot: MXN19.87 (MXN19.95)  

Median Bloomberg One-Month Forecast  MXN19.94 (MXN19.97)  

One-month forward  MXN19.95 (MXN20.02)     One-month implied vol 10.5% (10.7%)

  

 

Chinese Yuan: The dollar spent most of July within the trading range that had emerged in late June found roughly between CNY6.45 and CNY6.4950. The range was maintained even after the PBOC unexpectedly cut reserve requirements by 50 bp (announced July 9). However, Beijing's more aggressive enforcement of antitrust, discouragement IPOs abroad, making private education non-for-profit without foreign investment triggered sales of Chinese shares. It helped lift the dollar in late July to around CNY6.5150, its highest level in three months and just shy of the 200-day moving average.  The pursuit of domestic policy objectives appears to be putting at risk strategic goals.  A drying up of capital inflows from spooked foreign investors may have slow efforts to liberalize capital outflows that could eventually lead to making the yuan convertible.  At the same time, China's actions give a timely example of what holds the yuan back from a significant role in the world economy and why a technology solution (e.g., digital yuan) will not suffice.  As the dollar briefly traded above the upper end of its recent range in July, the risk is that it slips through the lower-end range, which could spur a move toward CNY6.40.  

 

Spot: CNY6.4615 (CNY6.4570)

Median Bloomberg One-month Forecast  CNY6.4555 (CNY6.4360) 

One-month forward CNY6.4780 (CNY6.4815)    One-month implied vol  4.0% (4.7%)

 

Disclaimer 



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