New Zealand’s 10-year bond yields rose 2.3bp to 2.83% overnight as the RBNZ signalled it would allow the economy to run hot before starting to reduce monetary accommodation in earnest. Similar to previous Fed communication, it indicated the ‘need for stronger capacity pressure than might otherwise be necessary to generate a given level of inflation’, prompting a fall in real interest rates weakening NZD. The rate projection continued to show the OCR would remain unchanged until mid-2019, in contrast to market pricing for the first hike by around August next year. RBNZ’s Wheeler and Mc Dermott have tried to be as explicit as possible that they don’t like the NZD trading as strong as today. Firstly their NZD forecast is lower than today. Secondly, they referred to the traffic light system of deciding when to intervene in FX markets, as an indication they are thinking about it. Finally McDermott stated specifically that the NZ dollar needs to adjust down. Long positioning in the NZD is at risk. Anyhow, the uncertain outcome of the upcoming General Election, signs of its housing market slowing down from overvalued levels and the upcoming leadership transition within the RBNZ should keep the NZD on the back foot, which should be best expressed by long AUDNZD.

The RMB is trading at the strongest level since mid-March, based on the CFETS basket. High real yields, a stable currency and a resilient economy seem to be transforming China into a local safe haven destination with continued tensions in Korea working as an additional catalyst for RMB strength. RMB strength has FX implications going beyond directly impacted currency pairs. The 10-year US – China yield differential has reached 141bp,not far off the 149bp reached in June. This not only keeps domestic funds within China, thus reducing the capital outflow risk; it may also attract foreign capital too. China’s FX reserves have started to rise again. Rising FX reserves suggest that there is an excess of hard currency to be recycled back into DM bond markets, keeping bond yields lower than otherwise suggested. In addition, some of the reserves may be reallocated away from USD, keeping the USD internationally offered. The second Exhibit shows the relationship between the DXY and USDCNH, suggesting China’s RMB push higher should especially keep EURUSD supported as the EUR acts as the alternative reserve currency to the USD.

Yesterday, we warned about risk turning tactically offered as investors de-risk their portfolios in light of the increasing Korea-related tail risk. Price action confirms that this move is about position squaring and not about the reassessment of the global economic outlook. Corrective activity occurred in places where positioning is extreme, while other market segments with low positioning have not joined the risk downside correction. Concretely, industrial metal prices continued to rally which looks even more impressive in the context of China’s recent tightening of its monetary conditions. The industrial metals rally supports the view of a strongly expanding global economy subsequently leading to reflation. Consequently, we view the current risk setback as providing a buying opportunity.