Incremental Dovish FOMC Expectations and Brexit Dominated Markets and Supported Solid Gains in Bond Markets

5 July 2016

Rates & FX Markets Monthly Review

Incremental Dovish FOMC Expectations and Brexit Dominated Markets and Supported Solid Gains in Bond Markets

Highlights

¨   US & UK:  Brexit and Fed rhetoric. Following a weaker than expected May NFP print (38K; consensus 160K) highlighting that weakness persists in the labour market, both USD and UST softened in the first part of the month on lowering expectations of a June rate hike (decision: no rate hike) before the EU’s referendum outcome spurred a flight to safety sending 10y yield to all time low at 1.38%, level last seen in 2012, while DXY parred its earlier loss closing marginally higher by 0.26%. Over in the UK, the month of June was dominated by Brexit-related news flow. The surprise decision for UK to vote in favour of leaving the EU spurred a massive downward move in the GBP (-8.09% m-o-m against the USD), and sent Gilt yields 34-56bps lower m-o-m as investors actively reprice towards further BoE easing over the coming months.

¨   Eurozone: 10y German Bund yield fell below 0% for the first time. Alongside poor inflation prospects, EGBs benefited from safe haven rally into global bonds ahead and following the UK’s decision to leave the EU; 10Y German Bund closed at -0.131%. For the same Brexit reason, gains were also extended to peripheral government bonds towards the end of the month with Spanish bond closing by -31.0bps on the 10y tenor. On the ECB side, expect further easing post-Brexit. On another hand, EURUSD traded sideways closing -0.23% lower, recovering 50% of the Brexit drop on the last days of the month amid easing fears. 

¨   Japan & Australia: JPY touched 100 against the USD. JPY played its safe haven role over the month with the USDJPY closing lower by -6.80%. The pair tested the 100 psychological handle as the Brexit outcome materialized, level likely to trigger further QQE easing and/or intervention as the continuous JPY strength is a source of pain for Japanese exports and further delays BoJ in meeting its inflation target. In Australia, RBA held rates at 1.75% after cutting rates in May, where minutes suggest that the bank remains watchful of AUD movements. AUDUSD climbed 3% m-o-m, with the pair retracing most losses sustained post-Brexit as investors opine that the fallout remains localised within the UK at the moment.

¨   Developed AxJ: Sluggish economic growth in Singapore continue to dull SGS safe haven status. Confounding decline in Singapore CPI reinforced expectations for MAS to ease further, dulling the allure of SGS as a safe haven asset, which spurred widening SGS-UST spreads above 40bps up to 10y tenor. SGS yields declined 6-33bps m-o-m while USDSGD tested but failed to hold below its 1.34 support amid further MAS easing expectations. Elsewhere, rallies in HKGBs mirrored USTs m-o-m, where resilience on the HKD via the peg continued to boost the attractiveness of HKGBs amid stretched gains on Asian FX. Meanwhile, KRW recorded the strongest gains m-o-m, undeterred by BoK’s surprise 25bps rate cut as Asian carry play resumed following dovish Fed expectations. In spite of the fiscal stimulus package announced in late June, yields on KTBs declined 23-34bps as investors continue to price in for another bout of BoK easing over the near term, given concerns on ramifications following Brexit.

¨   Emerging AxJ: Flows to AxJ buoyed gains on emerging AxJ assets. Following the EU referendum which favoured Brexit, surge in USD drove USDCNY beyond its 6.60 resistance, with the pair trending higher to 6.648 (+0.95% m-o-m), exacerbated by concerns of rising defaults among Chinese corporates which spurred capital outflows alongside broad gains on CGBs and CNH CGBs in June. Also, underwhelming PMI data continued to fuel apprehension on the Chinese economy, keeping investors positioned for further PBoC rate cuts. Meanwhile, ThaiGB curve bull flattened while USDTHB declined back to its 35.0 handle (-1.82% m-o-m) as deferring expectations for FOMC FFR hike spurred capital inflows into Thai bond market, driving yields lower by 11-36bps m-o-m undeterred by plans for elevated budget deficit in FY17 to fund heavy public investment spending as domestic investors continue to scale up the yield curve. In Malaysia, MGS yields and USDMYR fell 14-20bps and 2.42% m-o-m respectively, as accommodative DM monetary policies remain supportive of EM assets. May inflation edged marginally lower to 2.0% y-o-y, providing monetary policy flexibility to respond to rapid macroeconomic shifts, underpinned by stable MYR and oil price expectations. Indonesian assets rallied m-o-m as the risk-off resulting from Brexit proved fleeting, further underpinned by positive domestic drivers including the successful passage of the tax amnesty bill amid revisions to the 2016 budget. BI delivered a 25bps surprise rate cut, alongside the easing of macroprudential measures relating to loans, complementing the government’s fiscal spending plans. The INR was a clear underperformer in June, declining 0.39% against the USD m-o-m, as RBI governor Rajan’s planned departure alongside rising inflationary pressures weighed on sentiment; Gsec yield movements were subdued relative to AxJ peers, despite a massive global rally.