AUD
FUNDAMENTAL OUTLOOK: WEAK BULLISH
BASELINE
Despite a decent recovery from the start of the year, the AUD has struggled in the midst underlying negative risk sentiment, but the bigger short-term negative driver has been China’s covid struggles. China’s economy is always a key focus point for the AUD. While all major economies are expected to slow this year, China (which has been slowing for the past 18 months) is expected to recover (monetary and fiscal policy is at a big divergence between China and the rest of the world). This expected recovery in China has been a key positive driver for the AUD. As long as China’s recovery expectations remain alive, that should continue to support the Australian economy as it means further support for key commodity exports like Iron Ore, Coal and LNG . There was some news out this past week that China is looking to set up a centralized iron ore buyer to counter Australia’s dominance. Iron Ore has not taken this news well and will be an important one to watch as Iron Ore is Australia’s top export and 80% of it goes to China. The RBA finally woken up from their slumber and starting their hiking cycle fairly aggressively is also supportive for the AUD. The short-term problem to the current bullish bias for the AUD is the continued covid dilemma facing China right now. As long as the covid situation stays bleak, and China continues to lock down parts of the country due to their draconian covid-zero policy, the AUD might struggle to take advantage of the other positive drivers and makes it more sensitive to underlying risk.
POSSIBLE BULLISH SURPRISES
Positive Covid developments in China (easing restrictions, more fiscal or monetary stimulus, or letting go of the covidzero policy) could trigger bullish reactions in the AUD. As a risk sensitive currency, and catalyst that causes big bouts of risk on sentiment could trigger bullish reactions in the AUD. With the RBA just getting started with their hiking cycle, there is scope for them to turn more aggressive, and any catalyst that triggers higher hike expectations (RBA speak, inflation and wage data) could trigger a bullish response from the AUD. Any catalyst that triggers further upside in Australia’s key commodity exports (China stimulus, lifting covid restrictions, new infrastructure projects in China, higher inflation fears) should be supportive for the AUD.
POSSIBLE BEARISH SURPRISES
Negative Covid developments in China (increasing restrictions or adding additional ones) could trigger bearish reactions in the AUD. As a risk sensitive currency, and catalyst that causes big bouts of risk offsentiment could trigger bearish reactions in the AUD. Any catalyst that triggers downside in Australia’s key commodity exports (additional China restrictions, demand destruction fears, and additional news on recent centralized iron ore buyers) could be negative for the AUD. With the RBA just recently shifting policy and hitting the ground running on hikes, there is more room for them to get more aggressive, but of course any RBA speak or info in upcoming meetings that talks down aggressive hikes could still be a short-term negative for the AUD.
BIGGER PICTURE
The bigger picture outlook for the AUD remains positive for now, but that is largely dependent on what happens to China. The short-term covid issues have pushed back but not removed recovery expectations, but until the covid fog clears and the Chinese economy shows recovery signs, the AUD might struggle to maintain upside short-term momentum.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
Hawkish Fed policy remains a key driver for Dollar strength. With headline inflation >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. STIR markets suggests aggressive policy action pricing a terminal rate of >3.8% by 2Q23 which should be a positive input for the US Dollar . Safe haven flows have also supported the USD as it’s usually inversely correlated to the global economy and global trade, appreciating when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown, accompanied by multi-decade high inflation and synchronized removal of monetary policy stimulus from major economies has seen investors shun risk assets and even bonds (usually considered a safe haven), and the USD has been a key benefactor of the rush to safety as economic prospects have deteriorated. Even though US bonds are considered safe havens, the current high inflation has seen a strong stock-to-bond correlation and has caused big bond outflows. With bonds not fulfilling its usual save haven role the USD has benefited from the rush to safety.
POSSIBLE BULLISH SURPRISES
As aggressive Fed policy has been supporting the USD, any incoming data (especially inflation ) that sparks further hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger bullish reactions in the USD. As the cyclical outlook for the global economy is very bleak, and the USD is considered a safe haven, it means any incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger bullish USD reactions. Further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields like rising commodity prices and inflation expectations could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
More recently the USD has reacted more cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data slows, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad growth data could trigger bearish reactions in the USD despite its safe haven appeal. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is still close prior highs which acted aslocal tops for the USD. Thus, stretched positioning could make the USD vulnerable to mean reversion in the short-term. With a lot already priced for the Fed, it won’t take much for the Fed to disappoint markets on the dovish side. Thus, any FOMC comments that suggests more concern about the economy than inflation could trigger bearish reactions in the USD
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays aggressive and cyclical concerns put pressure on risk assets. But we do want to be mindful that lots has been priced for the USD, and growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed as a result of higher risks of recession. Furthermore, given tactical and CFTC positioning, we would prefer deeper pullbacks for new med-term USD longs, but shortterm catalyst can still offer shorter bearish sentiment trades against the current strong bull trend.
FUNDAMENTAL OUTLOOK: WEAK BULLISH
BASELINE
Despite a decent recovery from the start of the year, the AUD has struggled in the midst underlying negative risk sentiment, but the bigger short-term negative driver has been China’s covid struggles. China’s economy is always a key focus point for the AUD. While all major economies are expected to slow this year, China (which has been slowing for the past 18 months) is expected to recover (monetary and fiscal policy is at a big divergence between China and the rest of the world). This expected recovery in China has been a key positive driver for the AUD. As long as China’s recovery expectations remain alive, that should continue to support the Australian economy as it means further support for key commodity exports like Iron Ore, Coal and LNG . There was some news out this past week that China is looking to set up a centralized iron ore buyer to counter Australia’s dominance. Iron Ore has not taken this news well and will be an important one to watch as Iron Ore is Australia’s top export and 80% of it goes to China. The RBA finally woken up from their slumber and starting their hiking cycle fairly aggressively is also supportive for the AUD. The short-term problem to the current bullish bias for the AUD is the continued covid dilemma facing China right now. As long as the covid situation stays bleak, and China continues to lock down parts of the country due to their draconian covid-zero policy, the AUD might struggle to take advantage of the other positive drivers and makes it more sensitive to underlying risk.
POSSIBLE BULLISH SURPRISES
Positive Covid developments in China (easing restrictions, more fiscal or monetary stimulus, or letting go of the covidzero policy) could trigger bullish reactions in the AUD. As a risk sensitive currency, and catalyst that causes big bouts of risk on sentiment could trigger bullish reactions in the AUD. With the RBA just getting started with their hiking cycle, there is scope for them to turn more aggressive, and any catalyst that triggers higher hike expectations (RBA speak, inflation and wage data) could trigger a bullish response from the AUD. Any catalyst that triggers further upside in Australia’s key commodity exports (China stimulus, lifting covid restrictions, new infrastructure projects in China, higher inflation fears) should be supportive for the AUD.
POSSIBLE BEARISH SURPRISES
Negative Covid developments in China (increasing restrictions or adding additional ones) could trigger bearish reactions in the AUD. As a risk sensitive currency, and catalyst that causes big bouts of risk offsentiment could trigger bearish reactions in the AUD. Any catalyst that triggers downside in Australia’s key commodity exports (additional China restrictions, demand destruction fears, and additional news on recent centralized iron ore buyers) could be negative for the AUD. With the RBA just recently shifting policy and hitting the ground running on hikes, there is more room for them to get more aggressive, but of course any RBA speak or info in upcoming meetings that talks down aggressive hikes could still be a short-term negative for the AUD.
BIGGER PICTURE
The bigger picture outlook for the AUD remains positive for now, but that is largely dependent on what happens to China. The short-term covid issues have pushed back but not removed recovery expectations, but until the covid fog clears and the Chinese economy shows recovery signs, the AUD might struggle to maintain upside short-term momentum.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
Hawkish Fed policy remains a key driver for Dollar strength. With headline inflation >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. STIR markets suggests aggressive policy action pricing a terminal rate of >3.8% by 2Q23 which should be a positive input for the US Dollar . Safe haven flows have also supported the USD as it’s usually inversely correlated to the global economy and global trade, appreciating when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown, accompanied by multi-decade high inflation and synchronized removal of monetary policy stimulus from major economies has seen investors shun risk assets and even bonds (usually considered a safe haven), and the USD has been a key benefactor of the rush to safety as economic prospects have deteriorated. Even though US bonds are considered safe havens, the current high inflation has seen a strong stock-to-bond correlation and has caused big bond outflows. With bonds not fulfilling its usual save haven role the USD has benefited from the rush to safety.
POSSIBLE BULLISH SURPRISES
As aggressive Fed policy has been supporting the USD, any incoming data (especially inflation ) that sparks further hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger bullish reactions in the USD. As the cyclical outlook for the global economy is very bleak, and the USD is considered a safe haven, it means any incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger bullish USD reactions. Further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields like rising commodity prices and inflation expectations could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
More recently the USD has reacted more cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data slows, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad growth data could trigger bearish reactions in the USD despite its safe haven appeal. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is still close prior highs which acted aslocal tops for the USD. Thus, stretched positioning could make the USD vulnerable to mean reversion in the short-term. With a lot already priced for the Fed, it won’t take much for the Fed to disappoint markets on the dovish side. Thus, any FOMC comments that suggests more concern about the economy than inflation could trigger bearish reactions in the USD
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays aggressive and cyclical concerns put pressure on risk assets. But we do want to be mindful that lots has been priced for the USD, and growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed as a result of higher risks of recession. Furthermore, given tactical and CFTC positioning, we would prefer deeper pullbacks for new med-term USD longs, but shortterm catalyst can still offer shorter bearish sentiment trades against the current strong bull trend.