The tone was decidedly risk off throughout much of yesterday’s session as investors sought safe haven assets amid rising US-North Korea tensions and in what has thus far (thankfully) remained a war of words between the two countries’ leaders, President Donald Trump and Kim Jong Un, saw core curves bull flatten, peripheral spreads widen, 10 y US Treasury yields 3bps lower to 2.23% and 10 yr Bund yields 4bps lower (to 0.43%), explains the analysis team at Rabobank.
“Tensions have however eased somewhat overnight with US officials seeking to take some of the sting out of Mr Trump’s “fire and fury” rhetoric and Pyongyang reportedly devising plans for a strike on US assets in Guam ahead of submitting these to their supreme leader for a final decision. The fact that this latest escalation has thus far remained isolated to a war of words is clearly a welcome state of affairs but does highlight the reality that the unpredictable nature of North Korea’s regime and the US response to this is being taken seriously given the affirmation that Pyongyang is either near or has already achieved success at arming long range missiles with “miniaturised” nuclear capabilities.”
“As we open this morning, peripheral spreads are gaining traction after yesterday’s risk-off moves. The Italy-Germany 10 year spread had risen back above the 160bps level late in the session to hit 161.33 and has since tightened back (c.a 4bps). With a number of US officials suggesting Mr Trump had engaged in “reckless rhetoric” the Whitehouse has tempered its response and simply reaffirmed that the country would defend itself against any attack, along with its allies. The US secretary of State, arriving in Malaysia, suggested that the US has made positive inroads with the UN in terms of intensifying sanctions on North Korea which will likely see tensions continue to ease as Chinese and Russian officials weigh in to suggest that an escalation is clearly against the interests of all involved. That said, with the US and South Korea set to begin annual joint military exercises in the region this month, tensions will continue to simmer, at best, and highlights that the quieter summer trading weeks still remain highly susceptible to ongoing political headline risk that has dominated positioning throughout the course of 2017.”
“The next notable challenge investors will be forced to confront is the likelihood that the Fed will begin to trim its balance sheet as early as next month, if not simply announce its intentions to do so. Chicago Federal Reserve Bank President Charles Evans suggested overnight that it would be reasonable for the Fed to begin trimming its balance sheet “as early as next month”. Though the FOMC voting member has supported both rate hikes witnessed thus far in 2017, he has tempered views for a third hike this year by suggesting that inflationary pressures remain subdued, the one additional hike “on the table in December” could be delayed until later. Evans’ suggested there may be a need to offer the US economy further accommodation (by holding off hiking) in an effort to see inflation gather some additional pace.”
“Balance sheet normalisation is however being viewed (almost) in isolation from the potential fed funds rate hike with numerous Fed officials suggesting that an announcement would be appropriate in September. San Francisco Fed President John William’s stated late last week that the economy has gained enough traction to withstand a return to more normal policy and that a September announcement is consistent with what Fed policy makers have been signalling throughout the year as opposed to being an acceleration is the Fed’s intentions.”
“Indeed Fed presidents across the country have signalled they would begin the process this year, and in their latest communique said the policy would begin “relatively soon.” The Cleveland Fed President Loretta Mester repeated that statement last week, adding that the policy wouldn’t cause market disruption. Whether this forward guidance does prove enough to control (or simply contain) market tensions is the US$4.5 trn question. The fact that a number of Fed officials have made these statements with the added view that the balance sheet is no longer providing the US economy with the stimulus it did in the wake of the financial crisis seems to all but confirm that the path back to the future as regards Fed policy can be expected to unfold as summer fades.”
Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers.