Currencies
Without saying it, the BoJ introduced a price level target. While the announcement underwhelms in the details, its key implication is that the BoJ wrote a blank check to the government. Increased talk of cooperation between the government and the BoJ suggests more fiscal easing will materialize, which will ultimately hurt the yen. In the short term, markets will test the BoJ and the government's resolve.
The sharp spike in HIBOR will be short lived. The RMB "carry trade" has been largely unwound. The RMB will not experience the intense selling as seen in the past year. H shares are still trading at substantial discounts to A shares, which will inevitably continue to draw domestic investors. Strategically, H shares remain a better bet than their domestic counterparts.
We extracted the key factors driving currency returns; these variables approximate the dollar, EM spreads, and commodities. Any currency's sensitivity to these factors can be estimated, offering a great degree of flexibility for investors to generate trade ideas. Based on our macro views, this approach recommends being short commodity currencies and being long the dollar. The BoJ, BoE, and Riksbank are also covered.
The Treasury curve will bear-flatten between now and a likely December rate hike. Beyond December, our strategy will depend on how the dollar responds to increased rate hike expectations. For now, maintain below benchmark duration and favor convexity risk over credit risk.
Wedged between an improving labor market but icy global conditions, the Fed may be on the verge of conducting a policy mistake. This would be dollar and yen bullish. Commodity and EM currencies should bear the brunt of any pain. The pound's upside is limited, but so is the downside. NZD should soon buckle. Draghi did nothing, yet the euro rebounded little.
While a September rate increase is still possible, the recent batch of disappointing U.S. economic data, combined with lackluster inflation readings and election uncertainty, suggest that a December hike is much more probable. Similar to last year, risk assets are likely to react negatively to the prospect of further monetary tightening. Stay tactically short global equities and position for a stronger dollar.
The August payrolls report did not change our view that a Fed rate hike is likely in December, but not before that.
The dollar is likely to enter the bubbly stage of its bull market within the next 12 months. The key culprit for this move will not be the Fed, but easing by non-U.S. central banks. The euro area economy could enter a temporary soft patch, but this will not result in an imminent easing by the ECB.
The downside risks to the RMB are mainly an overshoot of the dollar as the Fed raises rates. The PBoC will allow the RMB to fall against the dollar if the dollar strengthens broadly, but a freefall is not in the cards. The RMB is unlikely to fall more than 5% against the dollar in the next 12 months, unless the latter appreciates by over 10% in trade-weighted terms.