AUD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
At the May policy decision, the RBA made a hawkish turn by raising the cash rate by 0.25% versus STIR expectations of a 15bsp move. Even though there were some hawkish takes looking for a 40bsp move, the 25bsp was still higher than consensus expectations. The bank noted that inflation pressures have risen more than they expected, even without a sharp rise in wages, and means that further increases in the cash rate will be required to bring inflation back in line with their target. They also surprised markets on the balance sheet side by announcing that they are starting passive QT by stopping the reinvestment of maturing bonds. The hawkish surprise was enough to see STIR markets price in >60% chance of a 50bsp hike for the June meeting despite comments from Gov Lowe who said they don’t preclude a bigger or smaller rate move than 25bsp in the future. All-in-all the decision from the RBA was hawkish and has finally kick started the bank’s hiking cycle and should provide support for the AUD in the med-term as long as the bank keeps tightening expectations intact.
2. Idiosyncratic Drivers & Intermarket Analysis
Apart from the RBA, there are 3 drivers we’re watching for the med-term outlook: Recovery – unlike other nations where growth & inflation is expected to slow, Australia is expected to see recovery, mostly thanks to stimulus in China China – With the PBoC & CCP stepping up monetary and fiscal stimulus, any recovery in China bodes well for Australia (China accounts for 40% of Australian exports). It also means the current virus situation in China posesshort-term downside risks for AUD. The AUKUS defence pact could see retaliation against Aussie goods and is worth keeping on the radar as well Commodities – Iron Ore (31%), Coal (14%) and LNG (10%) is more than 50% of Aussie exports, with rising prices giving the AUD huge support from terms of trade. If commodities remain supported it remains a support for AUD, but of course also means any sizeable corrections would weigh on the AUD, which means geopolitical and China demand developments remain focus points.
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
Very similar positioning change with Leverage Funds trimming net-shorts by a big amount but Asset Managers increasing net-short contracts by another big amount. With AUD aggregate positioning no longer stretched and mixed signals from CFTC categories, the CFTC data does not provide much in terms of signals for AUD.
5. The Week Ahead
With a quiet week ahead the main focus for the AUD will be on China developments, commodities and risk sentiment. On the China side, the market’s attention will turn to Covid developments. Even though we don’t think the Covid challenges changes the med-term outlook for China’s recovery, it has certainly pushed it back, and last week’s PMI data was much worse than expected. Any major negative Covid developments can place further pressure on the AUD, while further stimulus measures out of China would be seen as a positive. For commodities , Iron Ore is a key focus for the week ahead. Even though Iron Ore has held up very well in recent weeks despite China’s Covid predicament, this week saw Iron Ore break through key support and ending the week close to 5% down. If this downside pressure in Iron Ore continues it will be a negative driver for the AUD. Furthermore, the classic risk sentiment correlation has come back with a vengeance these past three weeks, which means overall risk sentiment and equity price action will also be in might be in the limelight for the AUD.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
At the May meeting, the Fed delivered on hawkish expectations regarding rates by hiking the Fed Funds Rate by 50bsp and also confirmed that the committee expects further 50bsp hikes to be appropriate. The fed also stuck to a familiar hawkish tone by downplaying the prospects of an imminent recession by explaining that even though the economy contracted in Q1, that household spending and business investment remained strong. The Chair also stuck to their guns regarding the rate path by suggesting that they think reaching neutral (currently estimated at 2.4%) before year-end would be appropriate and will assess the need for further hikes when they get there. There were however some less hawkish elements which saw a very classic ‘sell-the-fact’ reaction in major asset classes. The first one was on the Quantitative Tightening front where the bank decided on a phased approach for balance sheet reduction by starting the monthly caps at 30bn (treasuries) and 17.5bn ( MBS ) and pushing it up to the expected $60bn (treasuries) and $35bn ( MBS ) over a three-month timeframe. The second less hawkish element was comments from Chair Powell who took 75bsp hikes off the table saying the committee was not actively considering rate moves of that size. Interestingly, it seems STIR markets did not really believe the Fed as the probability of a 75bsp hike stood at >70% directly following the presser. All-in-all, the meeting provided a short-term ‘sell-the-fact’ opportunity, but also cemented the view that despite signs of a slowing economy and despite clear stress in financial markets, the Fed is sticking to their aggressive tightening for now.
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. The USD usually appreciates when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Thus, current expectations of a cyclical slowdown are a positive driver for the Dollar. Incoming data will be watched in relation to the ‘Fed Put’ as there are many similarities between now and 4Q18, where the Fed were also tightened into a slowdown. If growth data slows and the Fed stays hawkish it’s a positive for the USD, however if the Fed pivots dovish that’ll be a negative driver for the USD.
3. CFTC Analysis
Aggregate USD positioning remains close to 1 standard deviation above the mean, and close to prior tops where the USD topped out in previous cycles. That does not change the bullish outlook for the USD in the med-term but means that we would wait for pullbacks before initiating new longs with price at new cycle highs.
4. The Week Ahead
In the week ahead, the market’s biggest attention for the USD will turn to April CPI data, Fed Speak and Consumer Sentiment data. Even though there have been some clear signs that growth is slowing in the US economy, the Fed has kept up with promises of aggressive tightening this year as inflation is more than 4 times above target. Consensus expects headline inflation to drop to 8.1% from the prior of 8.5% and for Core YY to drop to 6.0% from 6.5%. This is mainly driven by base effects as April 2021 marks the month when price pressures started to really ramp up in the US. After the previous surprise miss in Core CPI and PCE , a bigger-than-expected miss in CPI could spark further speculation about ‘peak inflation’. Thus, any print close to or below the market’s minimum expectations could see some downside pressure in the USD and US10Y , as both are trading very close to cycle highs. We will also unfortunately be inundated by Fed speak next week as various officials will be running for the microphone to voice their own opinion of the May policy decision. As usual their comments will be watched closely for any new information that was not shared in the statement or during the presser with the Chair. We’ll also have updated Consumer Sentiment data, which will be important to see whether the bounce we saw from the prior reading is followed up with another, or whether sentiment deteriorates further from already recession territory lows. As always, risk sentiment will also be a focus for the safe haven Dollar.
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
At the May policy decision, the RBA made a hawkish turn by raising the cash rate by 0.25% versus STIR expectations of a 15bsp move. Even though there were some hawkish takes looking for a 40bsp move, the 25bsp was still higher than consensus expectations. The bank noted that inflation pressures have risen more than they expected, even without a sharp rise in wages, and means that further increases in the cash rate will be required to bring inflation back in line with their target. They also surprised markets on the balance sheet side by announcing that they are starting passive QT by stopping the reinvestment of maturing bonds. The hawkish surprise was enough to see STIR markets price in >60% chance of a 50bsp hike for the June meeting despite comments from Gov Lowe who said they don’t preclude a bigger or smaller rate move than 25bsp in the future. All-in-all the decision from the RBA was hawkish and has finally kick started the bank’s hiking cycle and should provide support for the AUD in the med-term as long as the bank keeps tightening expectations intact.
2. Idiosyncratic Drivers & Intermarket Analysis
Apart from the RBA, there are 3 drivers we’re watching for the med-term outlook: Recovery – unlike other nations where growth & inflation is expected to slow, Australia is expected to see recovery, mostly thanks to stimulus in China China – With the PBoC & CCP stepping up monetary and fiscal stimulus, any recovery in China bodes well for Australia (China accounts for 40% of Australian exports). It also means the current virus situation in China posesshort-term downside risks for AUD. The AUKUS defence pact could see retaliation against Aussie goods and is worth keeping on the radar as well Commodities – Iron Ore (31%), Coal (14%) and LNG (10%) is more than 50% of Aussie exports, with rising prices giving the AUD huge support from terms of trade. If commodities remain supported it remains a support for AUD, but of course also means any sizeable corrections would weigh on the AUD, which means geopolitical and China demand developments remain focus points.
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
Very similar positioning change with Leverage Funds trimming net-shorts by a big amount but Asset Managers increasing net-short contracts by another big amount. With AUD aggregate positioning no longer stretched and mixed signals from CFTC categories, the CFTC data does not provide much in terms of signals for AUD.
5. The Week Ahead
With a quiet week ahead the main focus for the AUD will be on China developments, commodities and risk sentiment. On the China side, the market’s attention will turn to Covid developments. Even though we don’t think the Covid challenges changes the med-term outlook for China’s recovery, it has certainly pushed it back, and last week’s PMI data was much worse than expected. Any major negative Covid developments can place further pressure on the AUD, while further stimulus measures out of China would be seen as a positive. For commodities , Iron Ore is a key focus for the week ahead. Even though Iron Ore has held up very well in recent weeks despite China’s Covid predicament, this week saw Iron Ore break through key support and ending the week close to 5% down. If this downside pressure in Iron Ore continues it will be a negative driver for the AUD. Furthermore, the classic risk sentiment correlation has come back with a vengeance these past three weeks, which means overall risk sentiment and equity price action will also be in might be in the limelight for the AUD.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
At the May meeting, the Fed delivered on hawkish expectations regarding rates by hiking the Fed Funds Rate by 50bsp and also confirmed that the committee expects further 50bsp hikes to be appropriate. The fed also stuck to a familiar hawkish tone by downplaying the prospects of an imminent recession by explaining that even though the economy contracted in Q1, that household spending and business investment remained strong. The Chair also stuck to their guns regarding the rate path by suggesting that they think reaching neutral (currently estimated at 2.4%) before year-end would be appropriate and will assess the need for further hikes when they get there. There were however some less hawkish elements which saw a very classic ‘sell-the-fact’ reaction in major asset classes. The first one was on the Quantitative Tightening front where the bank decided on a phased approach for balance sheet reduction by starting the monthly caps at 30bn (treasuries) and 17.5bn ( MBS ) and pushing it up to the expected $60bn (treasuries) and $35bn ( MBS ) over a three-month timeframe. The second less hawkish element was comments from Chair Powell who took 75bsp hikes off the table saying the committee was not actively considering rate moves of that size. Interestingly, it seems STIR markets did not really believe the Fed as the probability of a 75bsp hike stood at >70% directly following the presser. All-in-all, the meeting provided a short-term ‘sell-the-fact’ opportunity, but also cemented the view that despite signs of a slowing economy and despite clear stress in financial markets, the Fed is sticking to their aggressive tightening for now.
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. The USD usually appreciates when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Thus, current expectations of a cyclical slowdown are a positive driver for the Dollar. Incoming data will be watched in relation to the ‘Fed Put’ as there are many similarities between now and 4Q18, where the Fed were also tightened into a slowdown. If growth data slows and the Fed stays hawkish it’s a positive for the USD, however if the Fed pivots dovish that’ll be a negative driver for the USD.
3. CFTC Analysis
Aggregate USD positioning remains close to 1 standard deviation above the mean, and close to prior tops where the USD topped out in previous cycles. That does not change the bullish outlook for the USD in the med-term but means that we would wait for pullbacks before initiating new longs with price at new cycle highs.
4. The Week Ahead
In the week ahead, the market’s biggest attention for the USD will turn to April CPI data, Fed Speak and Consumer Sentiment data. Even though there have been some clear signs that growth is slowing in the US economy, the Fed has kept up with promises of aggressive tightening this year as inflation is more than 4 times above target. Consensus expects headline inflation to drop to 8.1% from the prior of 8.5% and for Core YY to drop to 6.0% from 6.5%. This is mainly driven by base effects as April 2021 marks the month when price pressures started to really ramp up in the US. After the previous surprise miss in Core CPI and PCE , a bigger-than-expected miss in CPI could spark further speculation about ‘peak inflation’. Thus, any print close to or below the market’s minimum expectations could see some downside pressure in the USD and US10Y , as both are trading very close to cycle highs. We will also unfortunately be inundated by Fed speak next week as various officials will be running for the microphone to voice their own opinion of the May policy decision. As usual their comments will be watched closely for any new information that was not shared in the statement or during the presser with the Chair. We’ll also have updated Consumer Sentiment data, which will be important to see whether the bounce we saw from the prior reading is followed up with another, or whether sentiment deteriorates further from already recession territory lows. As always, risk sentiment will also be a focus for the safe haven Dollar.