USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation, and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook for the US and the globe will be key for the USD. The USD is often inversely correlated to global growth & inflation, doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). 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 to see how the Fed responds to it, where a worsening outlook that deteriorates much faster than expected could see a dovish pivot from the Fed which could mean downside for the USD if money markets start pricing out hikes (especially with markets now expected just over 4 hikes for 2022).
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1458 with a net non-commercial position of +36434. The shortterm unwinding of stretched USD longs played out exactly as expected but was also short-lived in the midst of the recent strong risk off moves in certain parts of the market. Surprisingly, the big flush lower in the USD has not showed up in the CFTC data as expected with very little change to the overall positioning. In the current context, the stretched long positioning makes the USD vulnerable in the event that the Fed does not deliver the very hawkish tone expected of them in this week’s upcoming FOMC meeting.
4. The Week Ahead
For the USD the big focus this week will be overall risk sentiment and the first FOMC meeting for 2022 on Wednesday, followed by Friday’s Core PCE and Employment Cost index prints. The latter will of course be important given the inflation outlook with more emphasis recently on the odds of a possible wage spiral affect. However, the main event will be the FOMC, where the meeting is expected to serve as a signalling meeting to pave the way for a 25bsp hike in March and to provide more clarity on the bank’s balance sheet plans. With a March hike sitting close to a 90% probability, and markets already fully pricing in 4 hikes this year, the bar has been set quite high for a hawkish surprise. However, there are also some participants that think the recent econ data (CPI YY >7% and Unemployment <4%) justifies an early end to the Fed’s QE program instead of allowing tapering to run it’s planned course until March. That would certainly give a more hawkish feel to the meeting and could see markets pricing in an even earlier and faster pace of QT if confirmed. But, if the Fed does not deliver on an early end to QE, and does not offer a strong enough signal that the 4 hikes priced by the market is justified, we could be in store for some moderation in the rise in yields and the USD and could also prove to be supportive for equities which ended last week in quite bad shape.
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In Dec the BoC left rates at 0.25% as expected and maintained forward guidance where it expects rates at current levels until the middle quarters of 2022. This disappointed some participants who were looking for the bank to announce that the output gap could be closed in 1Q22. On inflation, even though the bank still thinks it will ease from 2H22, they did drop ‘temporary’ when referring to price pressures, similar to the Fed’s removing the word ‘transitory’. The bank took a slightly bleaker view on growth, pointing to both the new Omicron variant and flooding in British Columbia as possibly drags on growth and something that could elevate supply chain issues. What disappointed markets a bit was that the bank said none of the recent developments warrants any further adjustments to normalization, which disappointed the bulls looking for a possible hawkish tilt. The bank noted that employment is back to pre-covid levels, and economic momentum in Q4 were solid, but the overall tone wasn’t enough to convince markets of a Jan hike at that time, but markets have since then continued to ramp up hike bets with money markets pricing in a >70% chance of a hike at the Jan meeting and pricing in close to 6 hikes for 2022. Keep in mind that the bank was already concerned about growth before the recent Omicron restrictions, which means the likelihood of them bringing forward output gap projections seems unlikely and for that reason we think is setting up for a disappointment and possible repricing lower in money market expectations in the upcoming meetings.
2. Intermarket Analysis Considerations
Oil’s massive post-covid recovery has been impressive, driven by various factors such as supply & demand (OPEC’s production cuts), the strong global recovery which led to an improved demand, and of course ‘higher for longer’ than expected inflation. Even though Oil has traded to new 7-year highs last week, we are still cautious going into the first two quarters of 2022. The drivers keeping us cautious are expectations of a more hawkish Fed, slowing growth and inflation, lower inflation expectations (due to the Fed), a possible supply surplus in 1Q22, and a consensus that is very long oil (growing call for $100 WTI). If our concerns do materialize into downside for oil prices it should put pressure on the CAD. There have however been short-term drivers supporting prices and has kept the CAD more supported than we would have expected.
3. Global Risk Outlook
As a high-beta currency, the CAD 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 CAD.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +14868 with a net non-commercial position of +7492. We think the recent price action and positioning data has seen the CAD take a very similar path compared to April and Oct 2021 where markets were way too aggressive to price in upside for the CAD only to see majority of it unwind. We think the CAD is setting up for a similar disappointment with money markets way too aggressive on rate expectations for 2022, and the BoC will be a key test for the currency this week.
5. The Week Ahead
The main event for the CAD this week is the BoC meeting scheduled for Wednesday. From the start of the year, we’ve been growing more concerned with the CAD as money markets have been ramping up hike bets for the bank with 6 hikes priced for 2022 and a surprise 25bsp hike priced at an >80% probability at this week’s meeting. Have oil prices supported the CAD? Yes. Have the data been decent? Yes. However, recent data and oil prices does not mean the bank will suddenly have changed their mind about the output gap being closed, especially with the recently announced Omicron restrictions. Thus, if the bank was concerned about growth just a month ago, it’s unlikely that the picture changed drastically enough for the bank to hike rates this week. Thus, we think the overly aggressive hike bets means there is a very high bar for the BoC to surprise the market on the hawkish side, and means we see a higher chance for downside than upside for the CAD, unless the bank delivers a surprise 25bsp hike this week.
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation, and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook for the US and the globe will be key for the USD. The USD is often inversely correlated to global growth & inflation, doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). 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 to see how the Fed responds to it, where a worsening outlook that deteriorates much faster than expected could see a dovish pivot from the Fed which could mean downside for the USD if money markets start pricing out hikes (especially with markets now expected just over 4 hikes for 2022).
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1458 with a net non-commercial position of +36434. The shortterm unwinding of stretched USD longs played out exactly as expected but was also short-lived in the midst of the recent strong risk off moves in certain parts of the market. Surprisingly, the big flush lower in the USD has not showed up in the CFTC data as expected with very little change to the overall positioning. In the current context, the stretched long positioning makes the USD vulnerable in the event that the Fed does not deliver the very hawkish tone expected of them in this week’s upcoming FOMC meeting.
4. The Week Ahead
For the USD the big focus this week will be overall risk sentiment and the first FOMC meeting for 2022 on Wednesday, followed by Friday’s Core PCE and Employment Cost index prints. The latter will of course be important given the inflation outlook with more emphasis recently on the odds of a possible wage spiral affect. However, the main event will be the FOMC, where the meeting is expected to serve as a signalling meeting to pave the way for a 25bsp hike in March and to provide more clarity on the bank’s balance sheet plans. With a March hike sitting close to a 90% probability, and markets already fully pricing in 4 hikes this year, the bar has been set quite high for a hawkish surprise. However, there are also some participants that think the recent econ data (CPI YY >7% and Unemployment <4%) justifies an early end to the Fed’s QE program instead of allowing tapering to run it’s planned course until March. That would certainly give a more hawkish feel to the meeting and could see markets pricing in an even earlier and faster pace of QT if confirmed. But, if the Fed does not deliver on an early end to QE, and does not offer a strong enough signal that the 4 hikes priced by the market is justified, we could be in store for some moderation in the rise in yields and the USD and could also prove to be supportive for equities which ended last week in quite bad shape.
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In Dec the BoC left rates at 0.25% as expected and maintained forward guidance where it expects rates at current levels until the middle quarters of 2022. This disappointed some participants who were looking for the bank to announce that the output gap could be closed in 1Q22. On inflation, even though the bank still thinks it will ease from 2H22, they did drop ‘temporary’ when referring to price pressures, similar to the Fed’s removing the word ‘transitory’. The bank took a slightly bleaker view on growth, pointing to both the new Omicron variant and flooding in British Columbia as possibly drags on growth and something that could elevate supply chain issues. What disappointed markets a bit was that the bank said none of the recent developments warrants any further adjustments to normalization, which disappointed the bulls looking for a possible hawkish tilt. The bank noted that employment is back to pre-covid levels, and economic momentum in Q4 were solid, but the overall tone wasn’t enough to convince markets of a Jan hike at that time, but markets have since then continued to ramp up hike bets with money markets pricing in a >70% chance of a hike at the Jan meeting and pricing in close to 6 hikes for 2022. Keep in mind that the bank was already concerned about growth before the recent Omicron restrictions, which means the likelihood of them bringing forward output gap projections seems unlikely and for that reason we think is setting up for a disappointment and possible repricing lower in money market expectations in the upcoming meetings.
2. Intermarket Analysis Considerations
Oil’s massive post-covid recovery has been impressive, driven by various factors such as supply & demand (OPEC’s production cuts), the strong global recovery which led to an improved demand, and of course ‘higher for longer’ than expected inflation. Even though Oil has traded to new 7-year highs last week, we are still cautious going into the first two quarters of 2022. The drivers keeping us cautious are expectations of a more hawkish Fed, slowing growth and inflation, lower inflation expectations (due to the Fed), a possible supply surplus in 1Q22, and a consensus that is very long oil (growing call for $100 WTI). If our concerns do materialize into downside for oil prices it should put pressure on the CAD. There have however been short-term drivers supporting prices and has kept the CAD more supported than we would have expected.
3. Global Risk Outlook
As a high-beta currency, the CAD 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 CAD.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +14868 with a net non-commercial position of +7492. We think the recent price action and positioning data has seen the CAD take a very similar path compared to April and Oct 2021 where markets were way too aggressive to price in upside for the CAD only to see majority of it unwind. We think the CAD is setting up for a similar disappointment with money markets way too aggressive on rate expectations for 2022, and the BoC will be a key test for the currency this week.
5. The Week Ahead
The main event for the CAD this week is the BoC meeting scheduled for Wednesday. From the start of the year, we’ve been growing more concerned with the CAD as money markets have been ramping up hike bets for the bank with 6 hikes priced for 2022 and a surprise 25bsp hike priced at an >80% probability at this week’s meeting. Have oil prices supported the CAD? Yes. Have the data been decent? Yes. However, recent data and oil prices does not mean the bank will suddenly have changed their mind about the output gap being closed, especially with the recently announced Omicron restrictions. Thus, if the bank was concerned about growth just a month ago, it’s unlikely that the picture changed drastically enough for the bank to hike rates this week. Thus, we think the overly aggressive hike bets means there is a very high bar for the BoC to surprise the market on the hawkish side, and means we see a higher chance for downside than upside for the CAD, unless the bank delivers a surprise 25bsp hike this week.