The recent rebound in equity markets owes more to a recovery in bond yields than to any optimism over a stabilisation in the US, China trade situation.
It still remains highly unlikely that we will see a speedy resolution here and there remains a real risk that President Trump may turn his attention to the European Union given his remarks last week that the EU treats the US worse than China, when it comes to trade.
That being said US markets managed to close higher for the third day in a row after the US government delayed restrictions on Huawei for another 90 days, however they closed off their highs as some late caution set in and this is likely to translate into a flat open for European markets this morning, after markets in Asia also traded cautiously as China’s new floating loan rate changes came into effect.
We also saw the US 30 year continue its rebound from record lows near 1.95% to move up to 2.08%, while the US 2/10 spread has snapped back from being inverted last week, as concerns over a US recession subsided from some of the hysteria, we saw last week.
While the US appears to be some way from a recession the same cannot be said for Europe’s largest economy, where the narrative has shifted from monetary stimulus to some form of fiscal stimulus, after the Bundesbank announced that it was likely that the Germany economy would likely contract in Q3 which in essence would put the German economy into a technical recession.
This has prompted the inevitable speculation that the German government will embark on a significant fiscal stimulus plan, speculation that was given added legs yesterday on reports that there were indeed plans afoot prepare measures to shore up the German economy in the event of a deep recession, or a crisis.
The only problem with this narrative is that the German economy isn’t in crisis. It still has low unemployment and only contracted 0.1% in Q2. In comparison to ten years ago when the German economy contracted by 5%, we aren’t even close, and it is important to remember that Germany’s idea of a crisis may be quite different to everyone else’s.
This may help explain why German bond 2 year and 10-year yields closed the day relatively unchanged, near record lows, despite all of the excitement over a possible stimulus plan.
US yields were the biggest movers on expectations that any US rate cuts this year are unlikely to be as deep as markets are currently pricing in, despite President Trump upping his attacks on the Federal Reserve yesterday, again urging it to cut rates this time, by 100 bps.
Gold prices also slipped back, below $1,500 on the back of the improvement in risk sentiment.
The pound has started to show signs of building a possible short-term base despite the rising scepticism over a positive Brexit outcome. This appears to be as a result of excessive short positions, and with still two months to go there is still a lot of water that can flow under this particular Brexit bridge, at a time when Prime Minister Johnson is set to meet, both Angela Merkel of Germany and Emmanuel Macron of France in the coming days, in an attempt to change some of the key elements of the withdrawal agreement, and in particular the Irish back stop.
In a letter, addressed to EU Council President Donald Tusk he proposed replacing the backstop provision for a legally binding commitment not to build infrastructure, or carry out checks on the land border between Ireland and Northern Ireland. This would apply to both sides, with both sides pledging to look for alternative ways to overcome this particular problem in a transition period.
EURUSD – continues to look weak and as such could well slip back to retest the lows at 1.1020, and on towards the 1.0800 area. Key resistance sits at the 50-day MA and the 1.1250 area. We need to overcome the 1.1280 level to retarget the June peaks.
GBPUSD – while above the recent two-year lows at 1.2015, the pound looks vulnerable to a move higher. We still have major support sitting at the 1.1980 area. Needs to move back above the 1.2260 area to prompt further gains back to 1.2380.
EURGBP – a potential weekly reversal after the multi-year high at 0.9325 last week, raises the prospect that the top might be in. The break back below 0.9230, which is now resistance, could well see further losses towards 0.9000.
USDJPY – squeezing back towards the 107.00 area, a break above the 107.20 level could see a move back to the 108.20 area. We still remain vulnerable to a move towards the flash crash lows this year at 104.70, while below 107.20.