This past week, the German 10-year bond yield hit a new all-time low as it dropped to -0.727%. Overall, the total market value of negative yielding debt has now exceeded $16 trillion.
Negative yielding bonds, by definition, return less money at maturity than was paid at issuance. The question then becomes, who is holding all this debt and why do they desire to hold a negative yielding asset?
The simple answer is that a negative yielding asset does not guarantee a negative return unless it is held to maturity. However, if in the interim interest rates were to become more negative, the value of the bond would rise, allowing an investor to make a positive return by selling before maturity. Moreover, there is the question of available alternatives. Negative policy rates mean that banks have to pay money to deposit their excess balances at the central bank. As such, large deposits are often subjected to negative rates and this potentially makes bank deposits a less attractive alternative to corporates and asset managers.
The pervasiveness of negative rates is largely a function of expected weak economic growth. Markets have shifted into a risk off mode, further pushing down already low/negative rates. This then puts many central bankers in a difficult position. Banks such as the ECB and the BoJ are faced with increased pressure to ease due to weak economic performance; but, banks have a limited toolkit and lowering already negative rates not only has logistical complications but will also exacerbate the negative side effects of negative rates. The income effect illustrates how an erosion in income (negative interest) actually makes consumers pull back on consumption.
As such, markets will be watching the key bankers meeting in Jackson Hole, Wyoming next week where the theme will be “Challenges for Monetary Policy.” Not only are markets looking for direction on where negative policy rates go from here, but they will also be hoping to gain insights on how the recent run of strong US data plays into Jay Powell’s rate path outlook.
Poor data continues to come out of the EZ. This time, it was German Q2 GDP contracting by 0.1%, making a German recession more of a possibility. Comments from an ECB official that it’s better to “overshoot than undershoot” stimulus bolsters the case for ECB easing. The bias is still for EURUSD lower as domestic and global growth headwinds continue as trade escalation outweighs tariff delays.
Strong retail sales and firm CPI prints, along with steps to block a no-deal Brexit, helped move the GBP higher for the week. Ultimately, the GBP's path will depend more on Brexit. Expect the markets to sell rallies and the GBP to drift lower as the possibility of a no-deal Brexit remains in the markets. Parliament returns from recess in early September, after which volatility should spike higher.
USDJPY moved higher on the week despite US 10-year yields moving lower. The US announcing a delay in tariffs and a scheduled call between Trump and Xi have boosted trade optimism. However, escalated trade tensions should matter more than a delay in tariffs, and little progress has been made in US-China talks. Moreover, inverted yield curve conversations keep recession talks top of mind. With the markets still in a defensive mode, expect safe haven currencies, like the JPY, to remain in demand.
Last week was a quiet week for news and data, leaving the CAD to trade with overall market sentiment. Data should play a bigger role this upcoming week with inflation and retail sales on tap. A key measure to watch will be the market’s pricing for a surprise BoC move at its September meeting. To this end, the BoC has been looking through relatively strong domestic data and has focused more on global issues. It is anticipated that the loonie could be driven by domestic data over market risk sentiment in the coming week with the mentioned economic releases. Bias of CAD weakness leading into Wednesday’s inflation report.
After breaking above 7 last week, the CNY consolidated after sharply appreciating on the US tariff delay earlier in the week. Ultimately, the trade escalation should be more influential than a partial tariff delay. Persistent headwinds from the trade conflict biases the CNY towards further depreciation but expect the PBoC to maintain stability in the near term. Keep an eye out next week for a decision on Huawei.
After heavy selling due to concerns surrounding trade and Chinese economic growth, the AUD finished the week roughly flat as positive trade and economic news supported the currency. Positive jobs data gives the RBA room to be patient but further cuts are still expected due to weakening global and domestic data. RBA minutes this week will provide more insight into this. Near term, expect the AUD to be range bound to lower.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
No major central banks meeting this week.
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US July Existing Home Sales
Expectations for a 5.40 mm print
US August Manuf. and Services PMI
Expectations for a 50.5 and 52.8 print, respectively
US July New Home Sales
Expectations for a MoM decrease of 0.2%
Canada July CPI
Expectations for a YoY increase of 1.6%
Canada June Retail Sales
Expectations for a MoM decrease of 0.3%
EU July CPI
Expectations for a YoY increase of 1.1%
EU August Manuf. PMI
Expectations for a MoM decrease of 0.3 to 46.2
Germany August Manuf. PMI
Expectations for a MoM decrease of 0.2 to 43.0
Asia/Japan, and New Zealand
Japan Trade Balance
Expectations for the trade balance to narrow to -194.5 billion yen
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