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From the Floor: French jitters spark flight to safety— #SaxoStrats

#SaxoStrats
  • Worries about French presidential elections trigger flight to safety in bonds
  • Bond market moves benefit Bunds, weigh on France and EM bonds: Fasdal
  • European sovereign spreads widening : Fasdal
  • Schaeuble says euro too low for German competitiveness
  • Friday's NFP headline figure strong, but earnings growth a big disappointment
  • Unchanged forward expectations from the Fed: Hardy
  • Few catalysts for the dollar this week: Hardy
  • Banking stocks in focus after Trump vows to roll back Dodd-Frank rules: Garnry
  • Iran missile test boosts oil, but upside capped by increased US rig count
  • Oil bears are feeling increasingly lonely: Hansen
  • Gold holding above $1,220/oz
  • ECB’s Draghi scheduled to speak in European parliament on Monday

Saxo Strats banner
 

By John Acher

Worries about France's spring presidential elections are driving flight-to-quality flows in bond markets, benefiting Bunds and weighing on French and peripheral Europe paper.

The French presidential election — a two-round ballot to be held in April and May — looks like a wide open contest at this stage, and worries that centrist president Francois Hollande could be replaced by a leftist or anti-establishment populist politician are weighing on market sentiment in general and French bonds in particular.

"Core bonds are higher despite Friday’s [US] payrolls, and also this morning we had very strong factory orders out of Germany," says Simon Fasdal, Saxo Bank's head of fixed-income strategy. German factory orders were up in December to the highest level since 2011.

“It’s not all of the European bonds that are higher – it is more or less only the safe-haven markets where we see a small flight to safety already. Overall peripheral bonds continue the weakness we saw last week.”

Not only the French elections, but also uncertainty about the European Central Bank's possible tapering of its quantitative easing programme are causing worries for some issuers' bonds, Fasdal says. “With numbers like this that we got this morning from Germany, it is clear that we will see continued headlines from the Bundesbank as well."

“And it is a problem for Europe and the ECB that as the economy picks up in some countries, and we start to see spreads normalising and maybe also revealing the real credit premium on some of these countries,” says Fasdal, pointing to the following chart showing the 10-year spread between Portugal and Germany which is closing in on 4%.

Portugal vs Germany spread
 Source: Bloomberg and Saxo Bank

The picture is similar for many other countries, except for Spain.

“Corporate bond markets, however, continue to perform in line with better sentiment for equity markets,” Fasdal says, pointing to the European high-yield iTraxx crossover, which remains firmly below the 300 mark.

“And emerging markets continue the nice performance we have seen in 2017 both in equities and in bond markets,” Fasdal says.


US rate path unchanged

The US dollar outlook is still on the defensive, but bulls haven’t fully capitulated, says Saxo Bank's head of FX strategy John J Hardy.

“We felt last week might be pivotal – the support held for the dollar, but we haven’t seen a sign of a rally yet, so we need to see that this week. And there are few catalysts for the dollar this week, so we may be kept in suspense,” says Hardy.

On Friday, the US Labor Department's jobs report for January saw payrolls up more than expected, well above 200,000 jobs added, and the job-market participation rate improving, which caused a small uptick in the unemployment rate.

“But it was the earnings growth that was the focus after a very strong reading in December – the strongest for the cycle – we saw it dip back in the January numbers,” Hardy says. “That’s a big disappointment because that’s seen probably as the indicator that leads the Fed to stay on the path of three interest rate hikes, or more, this year.”

“Once again, after a somewhat indifferent FOMC at mid-week, there was a bit for both sides of the table on whether it was hawkish or dovish – the inflation language was rather hawkish – but essentially unchanged for forward expectations for the Fed,” says Hardy.

The 1.080-1.0850 zone remains a line in the sand for EURUSD, and 99-99.50 for the US dollar index, Hardy says.

“We still haven’t broken through there, so I hang on to my dollar-positive view until we break those levels,” Hardy says, adding that the corresponding level in USDJPY is around 111.70, though he prefers to focus on EURUSD and the dollar index at this stage.

USDJPY looking at 111.70
USDJPY
Source: Saxo Bank

One of the star currencies lately has been the Australian dollar, which has run steeply higher on the global inflation theme, hopes for Chinese commodities demand, and so forth, Hardy says, noting that the Reserve Bank of Australia holds an interest-rate meeting on Tuesday. But with recent weakness in commodities and mining stocks, it is hard to see the RBA waxing dovish, Hardy adds.

AUDUSD. Aussie dollar a star currency recently
AUDUSD
Source: Saxo Bank

 ECB president Mario Draghi was scheduled to speak in the European parliament on Monday. “The market has been happy to ignore his attempts at staying as dovishness as possible,” Hardy says.

Oil prices capped

Oil markets were showing the impact of increased US-Iranian tensions in the over past couple of days, heightened by a new Iranian test missile launch at the weekend.

“That has given the market a bit of a boost this morning,” says Saxo Bank's head of commodities trading Ole Hansen. "Previous events like this probably would have sent the market quite significantly higher than what we have seen this time around."

But oil prices are kept in check by a supply-and-demand battle where Opec is cutting, but the rig count in the US is on the rise.
 
“So the upside at this stage still seems to be capped. But clearly if we have a major event, then all bets are off and the market could move higher,” Hansen says.

At this stage, Brent crude is struggling with a band of resistance between $57.50 and $58.00/barrel. “That’s really the key area,” Hansen says.

The oil markets are looking forward to Opec’s monthly report on February 13, which will show January production.

“Oil bears are feeling increasingly lonely because the long side is getting increasingly crowded,” Hansen says. “WTI crude has been bought in 11 of the past 12 weeks -- we hit a new record last week -- so the market clearly believes that the price is pointing higher at this stage,” Hansen says.

Gold shines

Investment flows into gold in exchange-traded products were up sharply last week. Funds increased bullish bets by the most in two months.

“We are seeing the market holding above 1,220/oz,” says Hansen. “We have a bit of a trendline coming in at $1,225.”

The gold price has retraced 38.2% of the selloff from July, he says.

“As long as we can establish a foothold here, then the market is taking aim at $1,250/oz,” Hansen says.

Financial stocks are in focus after US president Donald Trump met with with key figures in the US financial community to discuss how to review the Dodd-Frank act, which Trump says is preventing credit from flowing to businesses.

“We had a reaction on Friday, I think it will continue all week,” says Peter Garnry, Saxo's head of equities strategy.

Garnry noted that equity markets are affected by developments in the FX markets and referred to remarks from German finance minister Wolfgang Schaeuble, who said in a newspaper interview that the euro was too weak for Germany and the ECB's expansive monetary policy has boosted the German economy's export surplus.

“So that’s at least a signal from one of the stronger players within the euro area that the euro could tick higher,” Garnry says.

Mr Fillon
 Francois Fillon, whose presidential campaign has been paralysed by 
a scandal over his wife’s 'fictitious' employment. Photo: Shutterstock


John Acher is a consulting editor at TradingFloor


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