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Summary
- As is common in August, reduced market liquidity has rendered trading conditions sub-optimal.
- This month has seen big moves, and sizeable retracements of those moves, across all global macro asset classes.
- We see these dynamics continuing for the next 1-2 weeks so keep our powder dry into September. Liquidity should improve then, and durable trends will either resume or newly emerge.
Market Implications
- We stand aside until next month, avoiding getting chopped around by the noise that has characterised markets this month.
- Subsequently, we think it will be worth positioning for lower US and UK short-end yields, in addition to a stronger euro (which we like to play in EUR/USD and EUR/CHF).
August Has Been a Wild, Noisy, Illiquid Month for Markets
The most recent US jobs report, released on 2 August, triggered sharp price moves across all asset classes.
On the day, the US 2-year yield fell 27bps, and the US Dollar Index (DXY) dropped 1.2%. Both were the biggest down moves of 2024. The S&P 500 fell 1.8% that day, the middle day of a three-day move that took the index down over 6%.
The most recent US payroll data was softer than expected across the board, and the dovish market reaction was justified. Yet these moves were exacerbated by poor market liquidity – a common feature in the month of August.
The S&P 500 has since recouped all of the big drop this month and closed yesterday just under 1% higher for August MTD. The 2-year US yield, however, is still well below the level at the end of July, as is the DXY.
Be Patient: Liquidity Should Improve in September
We see another week or two of sub-optimal market liquidity, which could elevate volatility. As such, we prefer to stay on the sidelines until next month, when the holiday season in the northern hemisphere ends.
For September, however, we like a handful of trades and will look to scale into positions once regular liquidity returns to markets.
Scale Into a Long Position in the US Short-End
The down move this month in US short-end yields has been eye-catching, but it is just part of a four-month trend that started in May. Since 30 April, the US 2-year yield is down over 100bps.
A lot of Fed easing currently priced into the US short end. Therefore, we stand aside for the next week or two before initiating exposure.
The US 2-year yield could retrace higher during this time. This, for us, however, would represent a corrective countertrend, rather than a durable trend reversal, which would be worth fading.
Although specific levels are difficult to pinpoint, the range between 4.15% (the close on 1 August, the day before the most recent US jobs data) and 4.40% would represent good levels from which to initiate long positioning, looking for lower yields.
Scale Into a Long Position in the UK Short End
The UK short end sees a similar story. Since 30 April, the UK 2-year yield is down almost 80bps.
Yet the two markets differ. While the US has about 100bp of easing priced in by yearend, the UK has only about 40bp of cumulative Bank of England (BoE) easing priced in for the rest of 2024.
Moreover, the UK has only about a 20% probability of a 25bp rate cut next month, versus over 30bps of easing priced into the next Fed meeting in September.
We recently argued the risk of a September rate cut is probably being underpriced.
Nonetheless, given the challenging liquidity dynamics outlined above, we take the same approach to building a long position in the UK short end as in the US – keep powder dry for the next week or two, and look to scale into a long position in early September.
On levels for scaling-in, ~3.80%/3.85% seen on 31 July the day before the BoE surprisingly cut rates on 1 August is a good starting point. The 3.9% level seen the week before may also be attractive.
Buy Dips in EUR/USD
EUR/USD is about 2.75% higher so far this month and, barring a sharp turnaround, is poised to have its strongest month since November last year.
Much like the US and UK short ends, which have seen price rallies since April, EUR/USD has also grinded higher. However, this rally has been subject to deeper setbacks along the way and has therefore been much more choppy.
All of this has been achieved within a relatively tight ~1.06/~1.1150 YTD range. So, it would not be unreasonable to conclude that EUR/USD will bust out of 2024’s tight price parameters.
And, since the pair is near the top of its YTD range, it is also not unreasonable to assume that the top end of the range is the weak side.
We are unconvinced. Sub-optimal liquidity conditions mean we could easily pull back to nearer the middle of the 2024 range on very little fundamental news in the next week or two.
The considerable easing priced-in to the US short end in recent months has been a big contributor to EUR/USD upside.
Still, one fundamental driver hints that we might be on the cusp, as liquidity returns and fundamental drivers emerge next month, of an upside breakout.
Currently, a full 25bps ECB rate cut is priced for their meeting on 12 September. But we are unsure. Recent data suggests the ECB will need to revise its forecasts more hawkishly at the September meeting.
This, plus the amount of incoming data, elevates the risk of the ECB pausing in September.
Given that a rate cut is fully priced, if we are right about an ECB pause, we think the euro will strengthen materially and could trade back to (and possibly above) the ~1.1250 level seen in July 2023.
For now, though, we prefer to be patient and buy on dips rather than rush in straight away.
Buy Dips in EUR/CHF
Our most recent G10 FX Weekly, published on 9 August, argued EUR/CHF was a buy-on-dips.
Two weeks ago, the pair had (intraday) traded to its lowest level since 2015 (~0.9211), the day the Swiss National Bank (SNB) abandoned the EUR/CHF ‘floor’ at 1.2000.
We had expected price action to remain volatile in EUR/CHF, but that any sell-off that approached ~0.9300 was a buy-on-dips.
Our view then, which we still hold, is that the SNB will not allow EUR/CHF to fall below the price trough seen earlier this month.
In June, the most recent SNB monetary policy update, not only did the Swiss central bank cut rates, is also explicitly stated it would push back against material CHF strengthening.
We think that this messaging will be repeated at the next SNB meeting on 26 September.
The market prices 32bps of easing at that meeting, and 50bps cumulatively by year-end, which is material, but also deliverable.
The SNB will not disappoint markets on the rate cut side and, more importantly, will work to keep CHF strength capped and ensure a controlled weakening of the currency.
As such, buying EUR/CHF on dips remains one of our favoured biases.
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