AUD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
At their Feb meeting the RBA delivered on expectations by announcing an end to QE purchases, and also upgrading inflation and employment forecasts. These were seen as hawkish developments, but the bank tried as hard as possible to still keep up a dovish impression by saying the ceasing of QE does not imply near-term rate increases and stating that it’s still too early to conclude that inflation is sustainably within the target band despite recent CPI prints. The bank maintained their view that the cash rate will not increase until inflation is sustainably within the 2%-3% target band. Now, call me crazy, but on that front, the bank’s projections forecast inflation to reach close to 3.25% this year and then see it returning to 2.75% during 2023, which surely implied ‘sustainable’
inflation. Comments from Gov Lowe the following day were slightly less dovish though by acknowledging that achievement of their inflation and employment goals are within reach. He also noted that even though it remains to be seen if rates will increase this year, there are clearly scenarios where the bank would be hiking this year (which was a step away from the tone and language used in the statement) but added that it’s still plausible that a first-rate hike is a year or more away. The February decision and tone could be summed up as an incremental step away from ultra-easy policy and means we have changed our Dovish stance for the bank to neutral.
2. Idiosyncratic Drivers & Intermarket Analysis
Apart from the RBA, there are 4 drivers we’re watching for the med-term outlook: Covid - so far, the RBA has been optimistic about the recovery, but incoming employment and inflation data will be crucial to see if that optimism is justified. China – Even with PBoC stepping up stimulus & fiscal support expected in 1H22, the Covid-Zero policy poses a risk to China’s expected 2022 recovery and incoming data will be important. Politically, the AUKUS defence pact could see retaliation against Australian goods and is worth keeping on the radar. Commodities – Iron Ore (24% of exports) and Coal (18% of exports) are important for terms of trade, and with both pushing higher on PBoC easing, it’s a positive for the AUD if they remain supported. Global growth – as a risk proxy, the health of the global economy is important, which means expected slowdown in growth and inflation globally needs monitoring, but if China’s recovery is solid the fall out could be limited for the AUD.
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
Stretched positioning are usually a contrarian indicator and warning of potential squeezes. Thus, right now the AUD might be more sensitive to positive data or developments compared to negative ones as a lot of bad news has been priced in. This week all eyes are on the Wage Index data as well as risk sentiment of course.
5. The Week Ahead
The time has finally arrived! This week will finally see the long-awaited and anticipated Wage Index data for Australia. Why is this such a big deal? Well, the RBA is obsessed with wage growth as they believe that without wage growth returning to close to 3% the chances of the bank reaching sustainable inflation within their target range is not possible. With Unemployment at 4.2%, CPI at 3.5% and GDP at 3.9%, the only piece of the puzzle that the bank needs to make their highly anticipated shift in policy is wage growth. In the bank’s defence, the historical chart for wage growth looks dismal, and despite recent upside we are still at historical lows. The trade is quite simple for wages, where a beat above the market’s maximum expectations is expected to see decent upside for the AUD as that will arguably see markets price in a policy shift from the RBA, while a miss below the market’s minimum expectations could see STIR markets coming back to earth and price out some of the 6 hikes priced for the bank this year. Apart from the wage index data, the other focus point will remain on risk sentiment with the ongoing tensions between Russia and Ukraine, where escalation is expected to be negative for risk sentiment (negative for the AUD) and any de-escalation is expected to be positive for risk sentiment (positive for the AUD).
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 Chair Powell portrayed a very hawkish tone. 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 (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility . But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language were a lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. 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. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
With the USD still sitting on the biggest net-long position for large specs and leveraged funds, the odds of mean reversion are always higher, especially with more than 6 hikes priced in for the Fed. However, if there is enough demand for safe havens due to further Russia/Ukraine challenges then positioning might not matter too much.
4. The Week Ahead
It’s a relatively quiet week for the US on the data front. Tuesday kicks off with Markit Flash PMI’s where focus will be on whether the recovery in Retail Sales and Industrial Production was also felt in the forward-looking and sentiment-based PMI’s. In terms of USD reaction, as both are growth measures, there is the chance the USD sees a similar inverse reaction like we’ve seen with other growth measures in recent weeks. On the inflation side we do have the Fed’s preferred measure of inflation (Core PCE ) on the schedule for Friday. As the Fed has tunnel vision for inflation right now the print will be important for us to watch. After a solid beat in CPI and PPI the market is skewed towards an upward surprise, which means it will arguably take a very sizable move above
maximum expectations to see a meaningful bullish reaction in the USD and US10Y , while it also means that a surprise miss, especially after CPI and PPI can have an outsized reaction to the downside for both. Fed speak will also be watched to see whether appetite for a 50bsp hike has grown. Keep in mind the Fed’s blackout period for the March meeting starts next week Friday (5 March), so any prep of a potential 50bsp move needs to be communicated clearly by the Fed before then in order to avoid jumping that type of surprise on markets when they don’t expect it. Risk sentiment will once again be a key potential driver for the USD given the heightened geopolitical risks around Russia and Ukraine. Any risk off flows from further fears of invasion or actual escalations should be supportive for the USD as the world’s reserve currency and a safe haven, while strong de-escalation is expected to be negative driver in the short-term.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
At their Feb meeting the RBA delivered on expectations by announcing an end to QE purchases, and also upgrading inflation and employment forecasts. These were seen as hawkish developments, but the bank tried as hard as possible to still keep up a dovish impression by saying the ceasing of QE does not imply near-term rate increases and stating that it’s still too early to conclude that inflation is sustainably within the target band despite recent CPI prints. The bank maintained their view that the cash rate will not increase until inflation is sustainably within the 2%-3% target band. Now, call me crazy, but on that front, the bank’s projections forecast inflation to reach close to 3.25% this year and then see it returning to 2.75% during 2023, which surely implied ‘sustainable’
inflation. Comments from Gov Lowe the following day were slightly less dovish though by acknowledging that achievement of their inflation and employment goals are within reach. He also noted that even though it remains to be seen if rates will increase this year, there are clearly scenarios where the bank would be hiking this year (which was a step away from the tone and language used in the statement) but added that it’s still plausible that a first-rate hike is a year or more away. The February decision and tone could be summed up as an incremental step away from ultra-easy policy and means we have changed our Dovish stance for the bank to neutral.
2. Idiosyncratic Drivers & Intermarket Analysis
Apart from the RBA, there are 4 drivers we’re watching for the med-term outlook: Covid - so far, the RBA has been optimistic about the recovery, but incoming employment and inflation data will be crucial to see if that optimism is justified. China – Even with PBoC stepping up stimulus & fiscal support expected in 1H22, the Covid-Zero policy poses a risk to China’s expected 2022 recovery and incoming data will be important. Politically, the AUKUS defence pact could see retaliation against Australian goods and is worth keeping on the radar. Commodities – Iron Ore (24% of exports) and Coal (18% of exports) are important for terms of trade, and with both pushing higher on PBoC easing, it’s a positive for the AUD if they remain supported. Global growth – as a risk proxy, the health of the global economy is important, which means expected slowdown in growth and inflation globally needs monitoring, but if China’s recovery is solid the fall out could be limited for the AUD.
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
Stretched positioning are usually a contrarian indicator and warning of potential squeezes. Thus, right now the AUD might be more sensitive to positive data or developments compared to negative ones as a lot of bad news has been priced in. This week all eyes are on the Wage Index data as well as risk sentiment of course.
5. The Week Ahead
The time has finally arrived! This week will finally see the long-awaited and anticipated Wage Index data for Australia. Why is this such a big deal? Well, the RBA is obsessed with wage growth as they believe that without wage growth returning to close to 3% the chances of the bank reaching sustainable inflation within their target range is not possible. With Unemployment at 4.2%, CPI at 3.5% and GDP at 3.9%, the only piece of the puzzle that the bank needs to make their highly anticipated shift in policy is wage growth. In the bank’s defence, the historical chart for wage growth looks dismal, and despite recent upside we are still at historical lows. The trade is quite simple for wages, where a beat above the market’s maximum expectations is expected to see decent upside for the AUD as that will arguably see markets price in a policy shift from the RBA, while a miss below the market’s minimum expectations could see STIR markets coming back to earth and price out some of the 6 hikes priced for the bank this year. Apart from the wage index data, the other focus point will remain on risk sentiment with the ongoing tensions between Russia and Ukraine, where escalation is expected to be negative for risk sentiment (negative for the AUD) and any de-escalation is expected to be positive for risk sentiment (positive for the AUD).
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 Chair Powell portrayed a very hawkish tone. 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 (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility . But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language were a lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. 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. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
With the USD still sitting on the biggest net-long position for large specs and leveraged funds, the odds of mean reversion are always higher, especially with more than 6 hikes priced in for the Fed. However, if there is enough demand for safe havens due to further Russia/Ukraine challenges then positioning might not matter too much.
4. The Week Ahead
It’s a relatively quiet week for the US on the data front. Tuesday kicks off with Markit Flash PMI’s where focus will be on whether the recovery in Retail Sales and Industrial Production was also felt in the forward-looking and sentiment-based PMI’s. In terms of USD reaction, as both are growth measures, there is the chance the USD sees a similar inverse reaction like we’ve seen with other growth measures in recent weeks. On the inflation side we do have the Fed’s preferred measure of inflation (Core PCE ) on the schedule for Friday. As the Fed has tunnel vision for inflation right now the print will be important for us to watch. After a solid beat in CPI and PPI the market is skewed towards an upward surprise, which means it will arguably take a very sizable move above
maximum expectations to see a meaningful bullish reaction in the USD and US10Y , while it also means that a surprise miss, especially after CPI and PPI can have an outsized reaction to the downside for both. Fed speak will also be watched to see whether appetite for a 50bsp hike has grown. Keep in mind the Fed’s blackout period for the March meeting starts next week Friday (5 March), so any prep of a potential 50bsp move needs to be communicated clearly by the Fed before then in order to avoid jumping that type of surprise on markets when they don’t expect it. Risk sentiment will once again be a key potential driver for the USD given the heightened geopolitical risks around Russia and Ukraine. Any risk off flows from further fears of invasion or actual escalations should be supportive for the USD as the world’s reserve currency and a safe haven, while strong de-escalation is expected to be negative driver in the short-term.