It’s Falling Apart: Reflation Trade Shrivels Up And Dies As Markets Sour On Risk

Well, the dollar is under pressure on Monday, just as we said it would be on Sunday evening.

The Bloomberg Dollar Spot Index fell as traders digested the failure of the GOP health care bill on Friday. This is the index’s eighth drop in the last nine days, and as Bloomberg notes this morning, “further losses of just 1.4 percent would mean the gauge will fully erase its gains since Donald Trump won the U.S. elections.” In addition to position-squaring, traders are seeing “fresh selling pressure, mainly by hedge funds.”

Needless to say, this is yen positive. Recall what we said last night:

So who has a guess as to what all of this means in terms of where you should place your FX bets? If you said “the currency that is tethered to US policy and serves as a barometer of the market’s faith in the US reflation narrative,” you win a prize.

Sure enough, Japan’s currency hit its strongest level since November 18.

Meanwhile, EUR/USD hit its strongest level since early December (just as we said it would) as the single currency enjoys leveraged and interbank demand, firmly remaining a buy-the-dip currency:

Panning out a bit, the entire reflation trade is under pressure, which should come as no surprise (see here). Indeed, some of this is likely traders catching up from Friday (see here).

Treasuries rallied in Asian trade as the health bill boondoggle dampened expectations for fiscal policy reforms. “Japanese investor buying seen in the 10y sector,” one trader told Bloomberg, adding that as Europe got going, the gains extends. Meanwhile, Asian real money was seen selling the front-end, ahead of 2y supply, while fast money was seen receiving in 10y bucket.

Here’s a bit of color from SocGen:

Failure to pass the Healthcare Bill doesn’t mean that President Trump’s entire agenda is in tatters but it’s a huge setback all the same and the market mood reflects as much. Bond yields, the dollar, commodity prices and equities are all weaker. The next market line in the sand is the 2.30% level for 10year Treasuries. Bond bears need some barnstorming data to remind us that the economy is in decent share. Sadly, the most exciting US data of the week comes in the form of personal income and spending data on Friday. Before then, we get Fed speakers galore but no economic news.

The only positive I can think of is that positions aren’t that big any more. CFTC data over the weekend showed that the huge speculative short position built up in 10year Notes in Q4 has now been completely unwound. Likewise the net USD long isn’t huge, though it’s been a while since the net long USD position has been more noteworthy than the short in bonds. If the big psychological level for US 10s is 2.3% that, roughly, looks like USD/JPY 109 on recent correlations (always assuming JGBs don’t move which, so far, is very much the case). Mind you, as we unwound the post-election moves, it’s worth remembering USD/JPY closed on November 8 at 105 (and 10year real yields were at 12bp).

The EUR/USD move isn’t only about the dollar. Better European economic data, German voters voting for the status quo and a lack of disquiet about the French elections all allow post November 8 moves to be unwound. Emmanuel Macron’s odds of winning the French elections, calculated by Bloomberg from Oddschecker.com, are now above 70%. There isn’t much on the calendar this week for Europe, with money supply and IFO this morning, preliminary CPI data in Germany and Spain Thursday, France and Italy Friday.

Speaking of IFO, that beat. To wit: