Talk From The Trenches: Breaking Bad Ranges And Testing Trade

By Bill Sokolis and Ed Hardy

US

How are market participants taking rates that broke multi-year ranges this week,

only a few days after the Federal Reserve Open Market Committee raised the

target range for the federal funds rate by 25bp, to 2.00%-2.25%?

Higher than expected ADP private employ data (+230k vs. +185K est) and the

largest two month increase on record for the ISM services PMI (61.6; biz index

65.2) spurred heavy selling Wednesday as Treasury 10Y yields climbed 10.3bps to

3.157%.

Carry-over selling after Fed Chairman Powell's late Wednesday comment "funds

rate is likely to get above 'neutral' (i.e., above 3%) at some point, albeit

slowly," pushed 10Y yields to 3.2305% Thursday, revisiting mid 2011 levels.

An MNI Sources story in which the ECB is said to pondering "a possible

Twist-like reinvestment of its maturing debt portfolios next year," helped pare

the surge in yield as the story spurred heavy buying in Bunds, with Treasury

futures close behind.

"Could the bond market be getting away from the Fed after Powell lavished praise

on current economic performance," one long-time market watcher queried. "Why are

rates going up?"

Perhaps it's the "end of the pension break in mid-Sept that had created demand

for longer dated assets" an "increase in the Fed's balance sheet normalization

to $50b/month," or "extra supply associated with massive fiscal deficits," the

source posited.

Maybe it's the "jump in cross-currency basis as 3-month terms covered the turn

(reflects funding pressures in terms of foreign buyers' demand for US paper

according to Bill Gross)," he added. Meanwhile, "Brainard's speech 2 weeks ago

about the rising neutral rate that the Fed may be actually not only have to

catch up to, but exceed (echoed by other Fed officials including Powell)."

A second market pundit suggested "If I were a voting member of FOMC I would want

rates up good bit higher than today. I think next recession is going to be

brutal unless Fed has ample room to cut. Yield curve be damned."

It's "easy to see next recession will be squarely on Fed's shoulders. There

won't be any fiscal room to maneuver."

ASIA

China's New Normal

Much of the media spotlight was, understandably, on the newly struck 'USMCA'

deal this week, tying up a trade deal between the US and its second and third

largest trade partners. But, this leaves China out in the wind, and if recent

reports are anything to go by, the prospect of an agreement between the two

nations is as distant as it ever was.

This has been reflected in the continued weakness of the CNY, despite official

forecasts eyeing a strengthening Chinese currency in all coming quarters out to

2020. This runs counter to hedging and volatility markets, however, which have

adjusted to the CNY's 'new normal'.

This may suggest markets are taking the PBoC at their word on the implied

'tolerance band' of CNY weakness up to 7.00. In fact, hedging markets are so

sanguine about the current tight range of USD/CNY that 3m realised volatility

this week traded at a premium to implied for the first time since the PBoC

adjusted their trading band regime in 2015.

The CNY's new normal may have significant repercussions for economies and

currencies closely linked with China. Protracted weakness in the CNY that

extends into the medium- and long-term may negatively impact Australia's terms

of trade, which has improved substantially from the 2015 lows. 

It appears this effect may already have begun to be priced in: this week AUD

touched multi-month lows against the USD, GBP and CAD. An extension of this

trend will see AUD traders being forced to keep an even closer eye on the

comings and goings in the White House.

Talk From the Trenches is a compendium of chatter from trading rooms, and is

offered as a gauge of the mood in the financial markets. It is not necessarily

hard, verified news.

--MNI Chicago Bureau; tel: +1 312-431-0089; email: bill.sokolis@marketnews.com