Steady US-China Trade Talks May Pressure Yen

If China to purchase more goods and services from US, short EUR/USD?

US Treasuries level to be the main factor to drive the FX market in next month

The US 10-year Treasury yield has pushed through 3%. Given the strengthening growth prospects which result in likely pickup in inflation pressures, higher rates should stay for some time. Rather than jeopardizing the longevity of the current cycle, moderate rising yields are instead a reflection of stronger economic fundamentals. While financial markets may need to adjust to a higher interest-rate regime, the economy is well positioned to adapt.

While monetary policy makers are on course to raise rates two more times this year, Fed officials have become increasingly vocal of late regarding the perils of inverting the yield curve. Atlanta Fed President Raphael Bostic went as far as to say that he viewed it as his duty to prevent a yield-curve inversion. The Fed funds futures market continues to reflect odds in the vicinity of 50% regarding a fourth rate hike this year. Unless longer-maturity yields continue to drift higher, policy makers may begin to bristle at the notion of a 3% fed funds rate at the end of 2019. Nevertheless, US monetary policy is set to be more aggressive than any other major central banks in the world. 

The 10-year inflation swaps continue to climb. However, while the 5-year forward 5-year TIPS inflation breakevens have turned over, they have not yet hit the 2.08% low reached in March. Inflation breakevens and the current CPI trend tends to move together since 2016. Part of the reason is that oil prices have been moving higher, driving current headline inflation. The challenge for forward headline inflation is that the backwardation in oil futures suggests oil prices may be lower in five years. This implies that core inflation expectations are much higher than the headline will be in five years. This will be good news to dollar in near term.

Monetary policy makers are on a firm course towards a rate increase at the June 12-13 FOMC meeting. The retention of "further gradual adjustments" language signals that policy makers are not looking to significantly accelerate normalization plans in 2018. Rather, their concern of late has focused on the perils of inverting the yield curve. A key focal point of the FOMC minutes this week will be to further distinguish the main thresholds separating the three- and four-hike camps in the 2018 dot plot. As such, the minutes may provide clues as to how they will ultimately compromise.

No trade war, best outcome in short-term

China will significantly increase purchases of US goods, the White House said as Beijing’s special envoy at talks in Washington declared a trade war has been averted between the world’s two largest economies. A joint statement released by the White House following the talks didn’t place a dollar figure on the increased purchases by China or address a comment by President Donald Trump’s top economic adviser suggesting Beijing had agreed to slash its annual trade surplus with the U.S. by $200 billion.

Xinhua news agency reported that Vice Premier Liu He, a special envoy of China’s President Xi Jinping, said that talks with U.S. officials, including Treasury Secretary Steven Mnuchin, Secretary of Commerce Wilbur Ross and U.S. Trade Representative Robert Lighthizer, ended with a pledge not to engage in a trade war.

Liu said the two sides agreed to stop “slapping tariffs’ on each other, he said his trip to the US had been positive, pragmatic, constructive and productive. Trade cooperation would be enhanced in such areas as energy, agriculture, health care, high-tech products and finance, a “win-win” choice for both nations.

China agreed to meaningfully increase in US agriculture and energy exports, the White House said. He added that the US will send a team to China to work out the details.                   

Our Picks

EUR/USD – Slightly bearish.

China to purchase more products likely to hurt some growth in the euro zone. This pair may drop towards 1.1680 this week.

USD/JPY – Slightly bullish.

We expect this pair to rise towards 111.80 amid US-China talk ended with no trade wars insight.

XAU/USD (Gold) – Slightly bearish.

We expect price to drop towards 1280 this week.