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Perspectives: Bonds and Currencies
393 Plays11 hours ago
In this episode of our Perspectives series, Steven Major, HSBC’s Global Head of Fixed Income Research, and Paul Mackel, HSBC’s Global Head of FX Research, discuss market developments and surprises across bonds and currencies.
This episode was recorded on the sidelines of the HSBC Global Investment Summit in Hong Kong on 25 March 2025. Find out more here: grp.hsbc/gis
Disclaimer: Views of external guest speakers do not represent those of HSBC.
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Transcript
Introductions and 2025 Market Surprises
00:00:05
Speaker
Welcome to Perspectives from HSBC. Thanks for joining us. And now, on to today's show.
00:00:14
Speaker
Welcome to another episode of HSBC Perspectives. My name is Stephen Major, Global Head of Fixed Income Research. And I'm Paul Mackel, Global Head of FX Research.
00:00:25
Speaker
And we're here today to discuss bonds and currencies. a very exciting area, we think at least, and one that's given us quite some surprise so far in
Bond Market Shifts in Major Economies
00:00:39
Speaker
2025.
00:00:39
Speaker
But by way of backdrop, Paul, I think we need to just reflect on on where we were at the start of the year. Last time we were here in Hong Kong, actually, at the Asian Outlook, and what's happened since then.
00:00:50
Speaker
Certainly for the bond market, I think that there's been quite some turning upside down in people's expectations from the end of last year. ah Bonds in China and Europe have seen yields go into reverse from what they were doing through the second half of last year. And the U.S. Treasury market has been rallying. That means the yields have been coming down.
00:01:12
Speaker
So in effect, what's been going on? The dollar has been going down this year. Well, it's a great starting point for the conversation, but you're absolutely right. There's been a big sea change in thinking from the start of this year.
00:01:24
Speaker
Many people thought that the dollar was going to keep strengthening and strengthening and strengthening. But in the last month or so, there's been a reversal of fortune, so to speak. As you said, it's been struggling.
00:01:35
Speaker
And there's a few things behind it. I mean, the first, of course, is a lot of fatigue with trying to understand the US administration's policies and what that could mean for the currency market, especially the dollar. So a roundabout tariffs. yeah The second thing comes down to big changes in Germany and how the market has perceived that. So the euro has done very well on the announcement of this big fiscal change. And of course, when you have the most actively traded currency pair move very quickly, and that has a rippling effect across other exchange rates. But the other thing which I think is relevant not only for me, but yourself,
00:02:11
Speaker
is how markets have been thinking differently about the U.S. growth outlook. And that, too, has been weighing on the
Fed's Growth Expectations and Market Sentiment
00:02:17
Speaker
dollar most recently. But for you, how are you thinking that in the context of the Treasury market? Well, look, you're right.
00:02:22
Speaker
The growth expectations have been starting to slip. And actually, the Federal Reserve itself revised down its growth forecast this year. They revised those down by more than they revised the inflation forecast up, for for example.
00:02:36
Speaker
So the bond market is taking this and thinking ahead and that's why I think yields have been slipping. the The Federal Reserve probably needs validation of the expectations that's coming through in the sentiment ah but before they follow through. But I think bonds are rationally following this path for growth that is more downwards than it was in 2024. on that note,
00:03:01
Speaker
which growth numbers would you be looking out for for this validation that treasury yields can can keep falling? Well, yeah, we can see in real time what some of the surveys are saying. yes and and And of course, we don't really ever know until it's too late what the actual numbers were to afterwards. But I think already there's evidence in the sentiment and in the confidence numbers. And Some of it is down to the policies, and yeah and and you've seen what's and what's going on, whereby ah <unk> they're looking at expenses at the federal level, and therefore confidence is going down.
Germany's Fiscal Changes and Market Reactions
00:03:38
Speaker
So I think that the the fiscal position is very, very different to what people had had expected coming into this year, and that may be part of the reason, Paul, that the yields have fallen. I have to ask you this question because it's it's front of mind for me.
00:03:54
Speaker
Is there that the surprise in Europe really the biggest surprise that you've that you've seen? ah it's It's a great question. And i mean, there's a number of surprises already in 2025. I mean, that's always the case every year in the currency market. But yes, I'd say what had happened in Germany, ah the the magnitude and how quickly things had changed was the biggest surprise. yeah I think that another surprise, of course, was just how elevated expectations were, how the Trump administration could be rolling out tariffs. And that's been happening, but not in the same way that it'd be lifting the dollar as as many people had thought. But what about for you in terms of surprises this year? Well, look, in my career, I'd say that the the surprise in Europe is maybe one of the biggest. Now, just to be very clear, this is the fiscal surprise in Europe, right? So it's Germany borrowing money beyond what was ever expected and releasing the debt break. That's the surprise. I think we can go back
00:04:51
Speaker
to the fall of the Berlin Wall to find a similar kind of scale in anything of this magnitude. So it's enormous. And it's a bit like the US is transferring some of the fiscal risk that it had on its own economy over to Europe.
00:05:06
Speaker
and and And therefore, you've seen a massive swing in the bond yields. Now, I suspect it's been overdone, Paul. And i think this I don't know how this feeds into currencies, but For us, maybe the Bund yield, the German bond yield, has gone up too quickly and all of those yields in Europe have overreacted.
Debt Supply and Central Bank Influence
00:05:25
Speaker
Now, if that's the case and they start sliding down again, it must have some FX implications. Well, certainly does. I mean, are seeing some early indications of that, that the optimism around this story, again, in the currency market with the euro trading very well, it's starting to stabilize. Let's see how things develop over the next yeah couple of months. But, you know, just sticking with this point of view, more debt, what does that mean in the context of bond yields in your framework?
00:05:53
Speaker
Well, you you know from some of the work we've done in the past that I tend to think that more debt, therefore more bond supply isn't really the reason for the yields to go higher. it's It's controversial, but I think we have to go beyond the intuition. What matters is what the central bank is thinking about the longer run growth and inflation and therefore what it means
Tariffs and the U.S. Economy: Dollar Implications
00:06:15
Speaker
for the equilibrium policy rate. well you What that policy rate is going to be.
00:06:19
Speaker
three to five years hence. And um so Germany may be taking on half a trillion, one trillion euros of extra debt over the next decade, who knows.
00:06:30
Speaker
But it's just Germany. That's not the whole of the eurozone. Germany is only one country. um So I think it's it's it's illogical that the yields have gone up by so much and they've gone up so much elsewhere in France, Italy and Spain, for example.
00:06:46
Speaker
and So, and also I would say that in the case of case of Germany, this is the best credit. This is the one country that could afford to borrow some more. So if this was a corporate, it would be like Apple or Microsoft. People would be queuing up to grab those bonds. So I don't really think it is as big a problem for the bond markets in Europe as the market has currently thought.
00:07:08
Speaker
And I have a lot of sympathy with that. But time will tell in the next few months whether the real data in Germany actually truly improves in contrast to some of the brightness in the survey data. but Steve, in terms of thinking about the next couple of quarters, what how are you looking at the bond market, especially the Treasury market and also Asia?
00:07:29
Speaker
So look, the the bond market is responding real time to what it thinks is going to happen in the next half of the year and through into 2026. And I think it's fair to say that the the market expectations for the Fed rate cuts have have have varied between zero and seven cuts in the last six months.
00:07:54
Speaker
So if we were to save three, it would be right in the middle of the zero to seven range. So I think second half of the year, the Fed's probably going to be back on that path they were on last September and take those policy rates back towards the 3% longer on equilibrium.
00:08:09
Speaker
that's ah That's our baseline. And our baseline is, well, first, we probably still have brace for impact of more tariffs. And what that could be meaning in the currency market is it probably should be giving the dollar the upper hand, at least initially. But the real focus for us could come down to, as I said, on growth. How is the U.S. economy holding up with those tariffs? The second thing is, how is the rest of the world holding up?
00:08:37
Speaker
and Do you think that tariffs are going to have the same impact on FX, on the dollar, as they did in the previous administration, or the one before, the the the previous Trump administration? because Because presumably, through time, we start to adjust to them. not Not that we know what the size and duration of the tariffs is going to be, because we're we're going to have to wait, right?
00:09:00
Speaker
I mean, at least in the first administration, because it was almost the shock and awe was greater. And we've been going through the scenarios and the narrative about tariffs being imposed this time around for quite a lengthy period. yeah So we can't conclude that it's in the price, but the mental exercise has been ongoing, I'm sure, for many.
00:09:18
Speaker
But I still think that there would be an impact where the dollar would likely rise. But The duration of it is is open to debate because the markets start to get more concerned about U.S. growth.
00:09:29
Speaker
Then that could change the dynamics of the dollar and what it could mean versus many other currencies.
China and Japan: Economic Stability and Bond Yields
00:09:35
Speaker
Can we just just move on to Asia, seeing as we're sitting here in Hong Kong, but but also because it just seems that we could be remiss here in one of the biggest developments. yeah Is it possible that China has has turned, that we've that we've got past the the worst?
00:09:53
Speaker
um And what about Japan? So in the context of the the currency, again, the renminbi side of the equation, we all know that it's been incredibly stable over the last few months when there's been some optimism around what the Chinese authorities is doing on fiscal and growth initiatives.
00:10:11
Speaker
On the other hand, there's been some hesitations too because the external tensions through the trade channel But it still seems that the currency is in a state of stability that may not last. It could be tested, just like many others in the coming months, if U.S. tariffs actually start to become more problematic. Of course, the opposite will also hold true.
00:10:32
Speaker
If those don't really materialize as a significant downward pressure on on the currency, then stability would continue. But the baseline is probably some modest depreciation is is likely. Yeah. But what about for you in terms of bond yields? Well, it seems that the bond yields may have found some kind of flaw. It's it's is tricky.
00:10:52
Speaker
The momentum last year and momentum, that's that's a word that we should explore some more because many of the position much of the positioning was about momentum. But Chinese yields were heading towards one percent last year. Now now it looks like maybe maybe we've turned.
00:11:08
Speaker
Things can't really go that much further. and And I think it's interesting for Japan as well, because look, if you told me a year ago that we'd have Japanese bond yields at this level, i would have been very surprised.
00:11:22
Speaker
in fact, Again, maybe maybe we're getting towards the highest point for Japanese yields. Just as Japan's hitting the top, maybe China's hitting the bottom. But this is where you can also have a disconnect between the currency market and the fixed income market because higher JGB yields have not translated into meaningful, stronger Japanese yen.
00:11:42
Speaker
Yeah. So it it doesn't always go according to plan. Well, this is what's interesting and this cause and effect. And this is where we've got this healthy tension between ah the bond market and FX. And sometimes we can have completely different views. It doesn't seem to matter, right? Because it depends on the time horizon. It depends on the context and what that.
00:11:59
Speaker
But it is true that maybe the Bank of Japan were hiking rates because the yen was so weak. And that may not be a factor going forward, right? Well, I often reference the last hiking cycle by the Bank of Japan, which was in mid 2006 to early 2007. And what had happened back then with the currency was actually went down. it didn't go up, even though that the Federal Reserve had its policy rate unchanged and we becoming increasingly concerned about the US housing market problems. But at the end, the dollar strengthened versus the Japanese yen.
Stagflation Risks and U.S. Monetary Policy
00:12:33
Speaker
In terms of things to look out for for the next couple of quarters, surprises, risks, what's on your potential radar? Look, we we try and think through these markets in terms of scenarios. And that that word stagflation keeps coming back in. I think technically it's very difficult to see it happening. That means you get consecutive quarters of negative growth and accelerating inflation. That's probably unlikely. But we we always have that. There's always a scenario whereby things don't quite go to plan and so somehow there's a policy error and you know from the from the central bank perspective, particularly in the US, if inflation really was taking off, then then they've got a problem and the bond market's got a problem. I ultimately think that yields are coming down because they have to. And it's really a it's about the budget. It's about what the what the U.S. can afford.
00:13:27
Speaker
And I think it is as as simple as that. But in terms of surprises, I think we have to be I think the the reason the Fed is being so cautious is because there there is always that chance that inflation was to take off again.
00:13:38
Speaker
But again, it's not our baseline. paul Look, ah Paul, thank you very much. It was nice to have the conversation.
Conclusion and HSBC Global Viewpoint Invitation
00:13:44
Speaker
Thank you. sir Thank you for joining us for this episode of Perspectives.
00:13:49
Speaker
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