Friday, May 31, 2019

Risk mood darkens further as Trump sets his sights on Mexico, yields drop to 20-month lows

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MORNING BRIEFING

Delivering another blow to risk sentiment yesterday, President Trump announced his intention to impose new tariffs, this time against Mexico. The US President went on Twitter to say that a 5% tax will be put in effect against all imports from the US' southern neighbor “until such time as illegal migrants coming through Mexico stop”. Safe haven assets rallied once more, with Gold moving above $1,290 and Dollar/Yen dropping below 109. Treasury yields hit a new low at 2.17% with Fed's vice chairman Clarida hinting on a potential rate cut in case of “a downside risk to the outlook”. Nevertheless, equities ended the day in positive territory but futures are now pointing lower.

The Dollar was unchanged against its peers on average but the US currency lost ground versus the Yen and Gold as Treasury yields continue to tumble. We were expecting this week to be an important one for the greenback but our focus was on the fresh US data, which failed to change the status quo. Having said that, volatility is once again on the rise but the catalyst was Donald Trump's tweet on Mexico. With yields coming under more pressure, the Dollar's direction is now under doubt ahead of the US inflation report, due later today.

Inflation is still one of the main concerns for the Fed, given that price pressures remain stubbornly low, despite a coordinated tightening effort from the US central bank over the past few months. In spite of that, economists are expecting a positive set of figures today which should help alleviate some of the concerns around inflation and could quash any early calls for interest rate cuts. If the report prints in line with expectations, the Dollar will likely receive a boost higher, especially versus the safe havens.

Dollar/Yen is trading just below 109 this morning on the back of the fresh rally to safety and this will be a key test for the currency pair. The 109 mark is an important psychological barrier and if prices fail to recover above it, then a deeper decline could be in the cards. A positive reading in the US inflation report should help in that direction, but beware of a nasty miss which could increase the flows towards the safe haven Japanese currency. Elsewhere, the Euro is attempting to carve a near-term bottom after reaching the 1.1120 lows but its price action hinges on the Dollar flows; more demand for the greenback following a strong US inflation report will expose the 1.11 area.

Gold was the main beneficiary of the risk aversion triggered by the new lows seen in the US Treasury yields. The yield on the benchmark bonds has now fallen to a 20-month low, with the 3m-10y spread growing further negative to -16bps as we enter the 5th consecutive day of this inversion. Prices are now about to test the $1,295 mark, which coincides with a descending trendline coming all the way from February; a successful penetration will clear the path towards $1,300 but a further extension may be hard if the US inflation data prints in a positive manner.

Finally, equities are pointing lower this morning following Trump's decision to impose tariffs on Mexico. It seems that the US President is so content with how his tactics have worked against China that he decided to use them again. His actions now put the USMCA deal in jeopardy even though Mexico can exert considerably lower leverage against its giant neighbor, compared to China. Nevertheless, equities have not taken the news in a positive fashion and futures on both sides of the Atlantic are pointing lower.

MARKET EVENTS TO WATCH

  • German Consumer Price Index - 4pm
  • US PCE Core - 4.30pm
  • University of Michigan Sentiment - 6pm

All times are GMT +4.

Written by Konstantinos Anthis, Head of Research