Global yields continue to tumble, mostly on fear or lack of returns and modest growth prospects. It’s beneficial to investors to understand the relationship between various yield spreads to better comprehend some of the recent currency moves. The rule of thumb is that a low rate environment does not make a currency that attractive to investors. One only has to look at the relationship of the EUR to the US/German 10-year spread; it has been correlating well with EUR moves of late. Judged by the moves after March FOMC and non-farm payroll, the market has been selling EUR strength. When the spread tends to widen EUR sellers tend to appear. The problem this week is that the market focus has been on lower U.S yields being backed by weaker data.
Nevertheless, the dollar continues to soar above the EUR in anticipation of the Fed preparing to raise interest rates later this year or early next, in contrast to the ECB. With the ECB committed to buying €1T in bonds until September 2016 – restricted to assets that yield more than the ECB’s deposit rate of -0.2% – its no wonder that there is a feeding frenzy for Euro product all along the curve. German Bunds continue to smash through record high prices or record low yields, using the ECB demand as their backstop.
Grexit fears favor German debt
It’s not just the ECB, but also Grexit fears that are driving German yields lower. Greek bonds are under pressure again this morning on the back of lowered market expectations over any reform proposals being forthcoming. This is raising the prospect of a possible default on May 12 when €747m is due to the IMF. The fear factor is blowing out Greek/German spreads again, back to their March highs (+1225bps). With German government debt considered to be some of the lowest risk globally it’s only naturally that there are in particularly high demand. Yesterday, S&P slashed Greece’s debt deeper into junk territory, saying it expects the country’s debt and financial commitments to be “unsustainable without deep economic reform.” This has pushed the yield on Greece’s 10-year bond to +12.3% while the yield on its two-year bond has ballooned to +25.3%. This inverted curve (short term yields are higher than long term yields) would suggest that the market is now betting heavily on a default.
This has been the cue for investors to try and smash the EUR/crosses lower this morning. EUR/CHF was driven lower through stops under €1.0290 on risk aversion. EUR/AUD and NZD has been sold by models post Aussie jobs data, while EUR/GBP has dropped to test new monthly lows around €0.7160 with sterling being used as a relative safe-haven play. The hopeful sellers will have to wait and see if this market squeeze can build further momentum.
Commodity currencies find much needed love
It seems that commodity currencies like the CAD ($1.2286) and the AUD ($0.7780) finally have a life of their own. Up until yesterday the pair had been sucking wind for a while, trading in a relatively tight range with investors suffering whiplash price effects. The loonie came to life not from the BoC rate announcement, or monetary policy forecasts, but from the price of crude. May WTI crude oil was up over +5%, rising over $56 a barrel for its highest level of the year and also testing the 100-day MA in about eight-months. The demand for crude has been supported by inventory data from the DOE as well as the API both showing smaller than expected build. The loonie was allowed to take flight aided by the dollar being weighed down by disappointing U.S industrial production data.
The CAD dollar’s other commodity sensitive and high yielding cousin, the Aussie dollar, has found much needed support on the job front. In the overnight session a particularly strong employment report down-under (+37.7k vs. +15.0k e; unemployment rate +6.1% -3-month low) has sent AUD/USD to a new two-week high this morning. While the data series has been volatile, the seasonal adjustment in this month’s figures would suggest that the Aussie labor market unease could have been overstated. Going into the release, fixed income markets priced in about a +70% chance of an RBA rate cut next month, but after the announcement, that probability has slid to just under +56%. The market will now focus on next week’s quarterly inflation report for conviction. Remember, the RBA has been very vocal in talking their currency down, deeming it very overvalued. It would not be too much of a surprise to see the RBA cut instead.