AUD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In Dec the RBA kept rates at 0.10% and weekly bond purchases at A$4bln until mid-Feb, as expected. They reiterated their commitment to maintain highly supportive monetary conditions and won’t raise rates until actual inflation is sustainably within their 2%-3% target range. They noted that the economy is recovering from the Delta slowdown and is expected to return to pre-Delta path in 1H22. The positive take from the meeting was that the RBA did not think Omicron will derail the expected recovery and sounded more optimistic than markets anticipated. They also said they will consider the future of their QE program at the Feb meeting and outlined their criteria for that which includes actions of other central banks, bond market functioning and actual and expected progress towards the goals of full employment and inflation consistent with their target. All in all, the bank still had a dovish stance but was more optimistic about the economy than expected. Furthermore, out of the 3 criteria set by the bank, it seems like all three have now been met following the past week’s CPI print.
2. Idiosyncratic Drivers & Intermarket Analysis
There are 4 key drivers we’re watching for Australia’s med-term outlook: The virus situation – so far, the RBA has been positive about a post-Delta recovery, but incoming employment and inflation data will be crucial to see whether that optimism is justified. China – Even though the PBoC has finally stepped up with new stimulus & some fiscal support is expected in 1H22, the Covid-Zero policy in China does pose a risk to their expected 2022 recovery so the recent rapid rise in cases is one to watch. Politically, the AUKUS defence pact could see possible retaliation from China against Australian goods and is always something to keep on the radar. Commodities – Iron Ore, (24% of exports) and Coal prices (18% of exports) are important for terms of trade, and with both pushing higher on PBoC easing, that is a positive for the AUD as long as they maintain their recent push higher. Global growth – as a risk proxy, the global economy is an important consideration for AUD, which means the expected slowdown in growth and inflation globally is an important point to consider, but if China can put in a solid year that should limit the fall out of a faster slowdown in the global economy.
3. Global Risk Outlook
As a high-beta currency, the AUD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the AUD.
4. CFTC Analysis
Latest CFTC data showed positioning change of +5181 with a net non-commercial position of -83273. As outsized net-shorts are usually seen as a contrarian indicator we want to be mindful of potential short squeezes, which also means the AUD can be more sensitive to positive data or developments compared to negative ones as a lot of the bad news has been priced. The recent wobble in equities have kept the AUD pressured, but it was encouraging to see that despite the equity downside the AUD managed to see some minor short unwinding.
5. The Week Ahead
Biggest focus in the week ahead is on Tuesday’s RBA meeting. Consensus believes that the three criteria the bank insisted on at their Dec meeting has been met, and thus believes the bank to announce an end of their QE program. However, it’s interesting to note this view isn’t shared by all, and some investment bank research suggests that the bank could simply opt to taper current purchases down to A$4 billion to A$2 billion, which would be seen as a dovish tilt from the bank and would disappoint current expectations. With inflation printing well above the bank’s 2-3% target band on the headline and Unemployment reaching 4.2% it seems that the bank is running out of excuses to keep up the overly dovish stance. However, as wage growth is always a major focus point for the bank, there is some credence to those who take a more sober approach to this upcoming meeting as we will only see 4Q21 wage data on the 23rd of Feb, which could give the bank an ‘excuse’ to simply taper purchases by half and explain they will review again in May. A decision to taper instead of end QE could certainly add additional weakness to the AUD, but we would think such weakness to be more limited given positioning, while an end to QE could see some further unwind of stretched net-shorts.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but the press conference from Chair Powell portrayed a very hawkish message. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes. Furthermore, the Chair explained that there is ‘quite a bit of room’ to raise rates without dampening employment, which suggests upside risks to the rate path, especially coming from Powell. A big question markets wanted an answer for was whether the Fed was
concerned about recent equity market volatility . However, the Chair explained that markets and financial conditions are reflecting policy in advance and stressed that in aggregate their measures they look at is not showing red lights. This was a clear message to markets that any ‘Fed Put’ is much further away and that inflation is the biggest focus point for the Fed right now. The Chair also didn’t rule out the possibility of hiking 50bsp in March or possibly hiking at every meeting this year, which was seen as hawkish as it means the Fed is looking for optionality to move more aggressive if they need to. On the balance sheet , we didn’t really get new info and the Chair reiterated that they are contemplating a start of QT after the hiking cycle has begun but also reiterated that they will discuss this in coming meetings. Overall, the tone and language used by the Chair were a lot more hawkish than the Dec meeting and more hawkish than some were hoping for.
2. Global & Domestic Economy
As the reserve currency, the USD’s usage around the world means it usually has an inverse correlation to the health of the global economy and global trade. The USD usually gains strength when growth & inflation both slow (disinflation) and loses ground when growth & inflation accelerates (reflation). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. So, incoming data will be crucial to watch. As long as growth data slows and the Fed stays aggressive that would be a positive environment for the USD, but if it causes the Fed to pivot more dovish and causes a rate repricing in money markets it would be seen as a negative input for the USD.
3. CFTC Analysis
Latest CFTC data showed a positioning change of +427 with a net non-commercial position of +36861. The shortterm unwinding of stretched USD longs played out as expected at the start of the year but was also short-lived in the midst of the recent strong risk off sentiment in certain parts of the market and of course the continued hawkish stance from the Fed.
4. The Week Ahead
In the week ahead the party starts all over again with a new month which means we’ll get new ISM PMI releases as well as the Jan NFP report. It’s important to keep the current economic climate in mind when looking at possible reaction functions for the USD. Usually, positive data should be USD positive and negative data USD negative when the Fed is busy with a hiking cycle, but right now there are growing fears that economic data has been slowing much faster than expected and means the Fed could be on its way to make the same mistake it did back in the end of 2018. As long as those fears persist, we might see the USD having two different reaction functions to growth and inflation data. Reacting inverse to growth data but acting correlated to inflation data. That makes this week’s incoming ISM data very interesting as the Dec data decelerated much faster than expected on the growth side, and a further miss might spark more fears about a faster slowdown. The tricky part for the USD in the week ahead is that both the ISM prints as well as the NFP report has inflation components with the ISM priced paid components and the Average Hourly Earnings on the NFP side. If growth data slows very fast that could be USD positive, but if inflation data starts decelerating much faster that could also be USD negative as it means less need for aggressive Fed policy. A tricky one for the week ahead.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In Dec the RBA kept rates at 0.10% and weekly bond purchases at A$4bln until mid-Feb, as expected. They reiterated their commitment to maintain highly supportive monetary conditions and won’t raise rates until actual inflation is sustainably within their 2%-3% target range. They noted that the economy is recovering from the Delta slowdown and is expected to return to pre-Delta path in 1H22. The positive take from the meeting was that the RBA did not think Omicron will derail the expected recovery and sounded more optimistic than markets anticipated. They also said they will consider the future of their QE program at the Feb meeting and outlined their criteria for that which includes actions of other central banks, bond market functioning and actual and expected progress towards the goals of full employment and inflation consistent with their target. All in all, the bank still had a dovish stance but was more optimistic about the economy than expected. Furthermore, out of the 3 criteria set by the bank, it seems like all three have now been met following the past week’s CPI print.
2. Idiosyncratic Drivers & Intermarket Analysis
There are 4 key drivers we’re watching for Australia’s med-term outlook: The virus situation – so far, the RBA has been positive about a post-Delta recovery, but incoming employment and inflation data will be crucial to see whether that optimism is justified. China – Even though the PBoC has finally stepped up with new stimulus & some fiscal support is expected in 1H22, the Covid-Zero policy in China does pose a risk to their expected 2022 recovery so the recent rapid rise in cases is one to watch. Politically, the AUKUS defence pact could see possible retaliation from China against Australian goods and is always something to keep on the radar. Commodities – Iron Ore, (24% of exports) and Coal prices (18% of exports) are important for terms of trade, and with both pushing higher on PBoC easing, that is a positive for the AUD as long as they maintain their recent push higher. Global growth – as a risk proxy, the global economy is an important consideration for AUD, which means the expected slowdown in growth and inflation globally is an important point to consider, but if China can put in a solid year that should limit the fall out of a faster slowdown in the global economy.
3. Global Risk Outlook
As a high-beta currency, the AUD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the AUD.
4. CFTC Analysis
Latest CFTC data showed positioning change of +5181 with a net non-commercial position of -83273. As outsized net-shorts are usually seen as a contrarian indicator we want to be mindful of potential short squeezes, which also means the AUD can be more sensitive to positive data or developments compared to negative ones as a lot of the bad news has been priced. The recent wobble in equities have kept the AUD pressured, but it was encouraging to see that despite the equity downside the AUD managed to see some minor short unwinding.
5. The Week Ahead
Biggest focus in the week ahead is on Tuesday’s RBA meeting. Consensus believes that the three criteria the bank insisted on at their Dec meeting has been met, and thus believes the bank to announce an end of their QE program. However, it’s interesting to note this view isn’t shared by all, and some investment bank research suggests that the bank could simply opt to taper current purchases down to A$4 billion to A$2 billion, which would be seen as a dovish tilt from the bank and would disappoint current expectations. With inflation printing well above the bank’s 2-3% target band on the headline and Unemployment reaching 4.2% it seems that the bank is running out of excuses to keep up the overly dovish stance. However, as wage growth is always a major focus point for the bank, there is some credence to those who take a more sober approach to this upcoming meeting as we will only see 4Q21 wage data on the 23rd of Feb, which could give the bank an ‘excuse’ to simply taper purchases by half and explain they will review again in May. A decision to taper instead of end QE could certainly add additional weakness to the AUD, but we would think such weakness to be more limited given positioning, while an end to QE could see some further unwind of stretched net-shorts.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but the press conference from Chair Powell portrayed a very hawkish message. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes. Furthermore, the Chair explained that there is ‘quite a bit of room’ to raise rates without dampening employment, which suggests upside risks to the rate path, especially coming from Powell. A big question markets wanted an answer for was whether the Fed was
concerned about recent equity market volatility . However, the Chair explained that markets and financial conditions are reflecting policy in advance and stressed that in aggregate their measures they look at is not showing red lights. This was a clear message to markets that any ‘Fed Put’ is much further away and that inflation is the biggest focus point for the Fed right now. The Chair also didn’t rule out the possibility of hiking 50bsp in March or possibly hiking at every meeting this year, which was seen as hawkish as it means the Fed is looking for optionality to move more aggressive if they need to. On the balance sheet , we didn’t really get new info and the Chair reiterated that they are contemplating a start of QT after the hiking cycle has begun but also reiterated that they will discuss this in coming meetings. Overall, the tone and language used by the Chair were a lot more hawkish than the Dec meeting and more hawkish than some were hoping for.
2. Global & Domestic Economy
As the reserve currency, the USD’s usage around the world means it usually has an inverse correlation to the health of the global economy and global trade. The USD usually gains strength when growth & inflation both slow (disinflation) and loses ground when growth & inflation accelerates (reflation). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. So, incoming data will be crucial to watch. As long as growth data slows and the Fed stays aggressive that would be a positive environment for the USD, but if it causes the Fed to pivot more dovish and causes a rate repricing in money markets it would be seen as a negative input for the USD.
3. CFTC Analysis
Latest CFTC data showed a positioning change of +427 with a net non-commercial position of +36861. The shortterm unwinding of stretched USD longs played out as expected at the start of the year but was also short-lived in the midst of the recent strong risk off sentiment in certain parts of the market and of course the continued hawkish stance from the Fed.
4. The Week Ahead
In the week ahead the party starts all over again with a new month which means we’ll get new ISM PMI releases as well as the Jan NFP report. It’s important to keep the current economic climate in mind when looking at possible reaction functions for the USD. Usually, positive data should be USD positive and negative data USD negative when the Fed is busy with a hiking cycle, but right now there are growing fears that economic data has been slowing much faster than expected and means the Fed could be on its way to make the same mistake it did back in the end of 2018. As long as those fears persist, we might see the USD having two different reaction functions to growth and inflation data. Reacting inverse to growth data but acting correlated to inflation data. That makes this week’s incoming ISM data very interesting as the Dec data decelerated much faster than expected on the growth side, and a further miss might spark more fears about a faster slowdown. The tricky part for the USD in the week ahead is that both the ISM prints as well as the NFP report has inflation components with the ISM priced paid components and the Average Hourly Earnings on the NFP side. If growth data slows very fast that could be USD positive, but if inflation data starts decelerating much faster that could also be USD negative as it means less need for aggressive Fed policy. A tricky one for the week ahead.