European Banking Woes Fueled Risk Aversion, Weighing on EGBs

30 September 2016

Rates & FX Market Update

European Banking Woes Fueled Risk Aversion, Weighing on EGBs

Highlights

¨   Global Markets: The array of Fedspeak had a fairly limited impact on USTs as investors appeared to have looked beyond the next FFR hike, with expections for monetary tightening trajectory to remain shallow. Stronger than expected US data failed to offset the rising risk aversion within global markets, with yields on USTs declining 1-2bps overnight; 2y and 10y USTs remained range bounded within 0.70-0.85% and 1.50-1.75% respectively since July. Over in EU, debates over Deutsche Bank woes and its potential USD14bn fine fueled risk aversion in the region given the potential spillovers throughout the weak banking system. Yields on 10y EGBs climbed 2-4bps overnight, where we maintain our recommendation for investors to favour core EGBs over its peripheral counterparts. Elsewhere, the lackluster CPI from Japan (Aug: -0.5%; Jul: -0.5%) reinforced the obstacles faced by BoJ policy makers amid increasing uncertainties within the global market; USDJPY climbed higher to 101.09 (+0.36%) yesterday, with hawkish Fedspeak and risk aversion over the coming week likely to continue easing downward pressure on USD.

¨   AxJ Markets: Deeper contractions in South Korea’s manufacturing PMI offset optimism stemming from the strengthening IP data released this morning, limiting further upward climb in KTB yields over the near term. With KRW assets remaining highly susceptible to FOMC FFR decisions alongside limitations towards BoK’s inclination to reduce policy rates aggressively, we recommend for investors to maintain the mild underweight duration view, with expectations for BoK to reduce only by 12.5bps in 4Q, capped by concerns over household indebtedness. Narrowing Fed-BoK policy rate differentials is also likely to hold a large bearing on KRW, where we expect the pair to climb modestly higher to 1150 by 2Q17, edging alongside the USDCNY pair.

¨   Oil prices sustained strong gains post OPEC agreement, but failed to bolster gains on commodity currencies, with AUDUSD falling to 0.763 overnight (-0.73%). The short-lived gains were attributed to weaker risk appetite stemming from Deutsche Bank woes and its potential spillover to European Banking system. Keep a neutral AUD view, with the OPEC November meeting to play a crucial role in influencing commodity currencies.