US TSY FUTURES: TY Blocked
Latest block trade lodged at 04:51:29 London/23:51:29 NY:
- TYZ2 1.6K lots blocked at 111-09+, looks like a seller.
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AUSSIE BONDS: A Light Bid Creeps In, Futures Volume Boosted By Rolls
A light bid has come into the space over the last hour or so, with YM lodging a fresh Sydney high as result, although both YM and XM continue to operate comfortably within the confines of their respective overnight ranges as participants look ahead to the impending U.S. CPI release. Roll activity continues to boost volume in the background, although the pace has slowed (when compared to Monday) ahead of Thursday’s expiry, with an estimated 55% of the YM roll complete and an estimated 66% of the XM roll conducted.
JGBS: Smooth 5-Year Supply
Today’s auction of 5-Year JGBs went well, with the low price topping wider dealer expectations (which stood at 99.810, proxied by the BBG dealer poll). The price tail narrowed slightly while the cover ratio improved to 3.79x from the previous auction’s 3.40x, rising above the six-auction average of 3.46x.
- As flagged in our preview, outright value factored into demand, with 5-Year JGB yields operating around the highest levels observed since the challenge of the BoJ’s YCC settings in mid-June, while the carry and roll of 5s vs. surrounding paper provided another positive factor for demand.
- The relative value of 5s also likely aided the absorption of the auction, with the belly of the 2-/5-/10-Year butterfly operating around the cheapest levels seen since the mid-June challenge of the BoJ’s YCC settings.
MARKET INSIGHT: EUR/USD Cheap To Short Term Fair Value, But Risks Still Loom
At face value, the EUR/USD rebound looks to have further to run. The first chart below plots spot EUR/USD against a simple cyclical fair value metric. The fair value metric is made up of the EU-US 2yr swap rate differential and the Citi relative terms of trade indices for the two blocs.
- The current fair value estimate sits above 1.04, versus current spot at 1.0130. The improvement in the fair value in recent weeks reflects higher swap rate differentials and a turnaround in the relative terms of trade outlook (albeit from depressed levels).
- Note the fair value regression is based off the past year of data and has an R^2 of 87%.
Fig 1: EUR/USD Still Below Simple Simple Cyclical Fair Value
Source: Citi/MNI - Market News/Bloomberg
- Interestingly though, recent correlations suggest the relative terms of trade back drop is a more important driver of EUR/USD, rather than yield differentials. A trend that has been evident in other parts of 2022 as well.
- This is closely linked with another key driver of the EUR/USD outlook, relative growth prospects between the EU and US. The second chart below overlays EUR/USD against the ratio of EU growth revisions to US growth reversions, sourced from J.P. Morgan.
- Not surprisingly, J.P. Morgan economists have revised down their EU growth projections more than the US, most notably in recent months. This has been the broader trend from other economists as well.
- The potential for an energy supply induced recession in the EU area certainly can't be discounted as we approach year end. A further sharp downward revision to the EU growth outlook, relative to the US, would weigh on the EUR/USD rebound, all else equal.
- On this basis, the market may be reluctant to take EUR/USD quickly back to the implied level of short term fair value, particularly ahead of the northern hemisphere winter.
Fig 2: EUR/USD Versus Relative J.P. Morgan Growth Revisions (EU to US)
Source: J.P. Morgan/MNI - Market News/Bloomberg
