JPMorgan's Latest Macro Outlook: Continue Betting on U.S. Yield Curve Steepening and High-Yield Currencies, Beware of Oil Market Supply-Demand Divergence

According to Odaily, J.P. Morgan recently released a research report providing an outlook on the macro environment, including global interest rates, foreign exchange, commodities, and emerging markets. J.P. Morgan believes that Federal Reserve Chair Powell’s recent statements support a moderate decline in short-end yields and a steeper yield curve, and therefore maintains its position of going long on the 10-year vs. 30-year U.S. Treasury yield curve steepener trade. The outcome of the U.S. midterm elections may have divergent impacts on the dollar, but overall policy effects are limited, and the relative strength of the U.S. stock market is expected to continue supporting the dollar. As long as there is no significant volatility shock or economic growth shock, substantial global interest rate differentials will continue to provide medium-term support for carry trades. In commodities, attention centres on disruptions in the energy supply chain, downside risks to copper prices, and weather changes in South America. Emerging markets are facing multiple challenges from energy prices, financing costs, and fiscal pressure.

Global Interest Rates

Regarding U.S. interest rates, J.P. Morgan believes that the Fed Chair's performance at the press conference after last week's rate decision supports a moderate decline in front-end yields and a steeper yield curve. Considering the market’s expectations for the Fed’s mid-term policy, the yield curve currently remains relatively flat. If the U.S. Treasury does not make significant adjustments to its debt management strategy, the curve should become steeper. Therefore, the bank maintains its position of going long on the 10-year vs. 30-year U.S. Treasury yield curve steepener trade. Given that the current characteristics of the yield curve trade resemble a low-beta duration long position, if the initial signs of weakness in risk assets further spread, this strategy is expected to benefit.

In the November refunding announcement, J.P. Morgan expects that forward guidance, nominal coupon bond auction sizes, and repo operations will all remain unchanged. The risks lean towards the Treasury reducing the size of long-term bond auctions, but the bank sees no reasonable grounds for such action at this time.

Last week, developed market (DM) rates performed mixed, with U.S. Treasury yields outperforming other markets. Market focus remains on geopolitical tensions and the ongoing weakness in technology stocks amid disappointing earnings. In addition, central bank meetings (Fed, ECB, Bank of Japan, and Reserve Bank of New Zealand) as well as the UK budget announcement have also attracted market attention.

Foreign Exchange

The U.S. midterm elections will take place on November 3 local time. A comprehensive Democratic victory could exert mild downward pressure on the dollar; if Republicans perform unexpectedly well and retain the Senate, it could be positive for the dollar. Overall, J.P. Morgan expects that regardless of the outcome, policy-level impacts will be relatively limited, and the relative strength of the U.S. equity market will persist, ultimately providing support for the dollar.

The drawdown of carry trades has further expanded. Although investors may have reason to reduce risk exposure to protect year-end portfolio gains, as long as there are no volatility shocks or negative growth surprises, the medium-term outlook remains positive, given the still-wide yield differentials among currencies.

J.P. Morgan remains positive on high-yielding currencies within the G10, including the Australian dollar, Norwegian krone, and U.S. dollar. However, for emerging markets, the bank’s strategists have become more cautious, adopting a more selective approach. For high conviction carry trades, the bank now prefers to use the euro as the funding currency rather than the Swiss franc or Japanese yen.

G10 central bank meetings are still ongoing. Meetings at the Reserve Bank of Australia, Bank of England, and Norges Bank will continue to support the bullish logic for the Australian dollar, pound sterling, and Norwegian krone; while the Swedish central bank lacks the capacity to reverse the weakness in the Swedish krona.

Commodities

J.P. Morgan points out that the economies of most regions globally continue to grow, with many economies growing at rates above their potential levels. However, at the same time, oil consumption is contracting, with some regions experiencing shrinkage at rates usually only seen during recessions.

Since the U.S. and Israel took military action against Iran and the effective closure of the Strait of Hormuz, Middle Eastern oil exporters have maintained energy shipments through bypass pipelines, alternative transport routes, dark-mode sailing (turning off vessel tracking), and ship-to-ship transfers (STS transfers).

Regarding the copper market, although fundamentals remain generally supportive, J.P. Morgan shifted to a more cautious and uncertain stance last week, focusing on downside risks. These risks mainly centre on the U.S.'s continued lack of tariff action, which could cause earlier mispriced premiums in copper to unwind.

Following the recent sharp fall in prices, U.S. export competitiveness has improved, warranting ongoing attention. Weather remains a key factor, particularly in South America, where rainfall anomalies associated with El Niño continue to intensify. After the U.S. midterm elections, market focus will shift to the "World Agricultural Supply and Demand Estimates" (WASDE) report released by the USDA on November 10.

Emerging Markets

J.P. Morgan says that as energy prices and yield pressure continue to transmit into fiscal dynamics, markets are starting to show signs of strain, volatility is rising, and growth expectations are affected. The bank’s base case scenario remains that a reflationary environment will prevail, providing further returns for emerging market FX carry trades. However, the bank is trimming portfolio size, focusing investments on currencies with the highest carry returns, as well as opportunities with the strongest unique drivers.

J.P. Morgan notes that the room for markets to further reprice terminal rates is now facing some new constraints. Meanwhile, the bank remains cautious on the long end of the yield curve, as fiscal concerns and supply-demand factors have not yet been fully reflected in curve steepening and asset swap spreads.