CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Despite STIR markets pricing in close to an 80% chance of a 25bsp hike, the BoC chose to leave rates unchanged at their Jan meeting. However, the bank removed its extraordinary forward guidance and said they now think the economic slack has been absorbed (previously expected to occur somewhere in the middle quarters of 2022). The bank also explained that they expect rates will need to rise based on the progress of inflation, and Gov Macklem explained their only reason for not hiking was uncertainty surrounding Omicron. The statement gave a clear signal that a March hike is on the table. Furthermore, on the balance sheet the bank delivered on expectations by noting they will likely exit the reinvestment phase as rates begin to rise. Even though 2022 inflation projections were upgraded, the bank also downgraded growth forecasts (which in our view remains a key reason why current STIR market expectations are not realistic). Thus, the meeting had both dovish and hawkish elements to it, and thus means we are still happy to hold to a neutral bias for the CAD.
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), strong global demand recovery, and of course ‘higher for longer’ than expected inflation. Even though Oil has traded to new 7-year highs, we think the current Russia/Ukraine tensions and recent tight capacity concerns are the biggest contributors to the upside as our cautious view going into Q1 & Q2 remain intact. The drivers keeping us cautious are A hawkish DM central banks targeting demand, slowing growth and inflation, lower inflation expectations (due to the Fed), a consensus that is very long oil (growing calls for $100 WTI). Recent geopolitical risks regarding Russia/Ukraine have been a key focus point for oil, but the increased chances of an Iran nuclear deal took some of the upside momentum away this past week. If Russia/Ukraine tensions stop sending oil prices higher, that tells us something about sentiment.
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
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 and optimistic to price in upside for the CAD, only to then see majority of it unwind. We think the CAD is setting up for a similar disappointment with money markets too aggressive on rate expectations for 2022.
5. The Week Ahead
Focus for the CAD is twofold this week with risk sentiment and Oil in focus. On risk sentiment and Oil, it’s a mixed bag for the CAD. Even though the oil market’s initial reactions to escalation and de-escalation were as expected, we did see the impact fading this week as some focus returned to the possibility of an Iran nuclear agreement came back on scene. We’ve initiated a new short on oil this past week (check out the rationale in the Trade Idea tab of the terminal), and if our rationale is correct and oil sees some downside in the sessions ahead, that opens up more room to the downside for the CAD as well. Then we have risk sentiment, where any further escalation is expected to be negative for risk sentiment (negative for the CAD) and any de-escalation is expected to be positive for risk sentiment (positive for the CAD). Just keep in mind that even though oil prices started to react less to geopolitical risks this past week doesn’t guarantee that it will continue to do so in the week ahead. However, if oil prices do react stronger to geopolitical risks that will make the CAD a tricky one to trade as oil and risk sentiment would move inverse to each other and mean the CAD could have both a push and pull effect on the CAD.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
No surprises from the BoJ at their Jan meeting. Despite some source reports which surprisingly suggested that the bank was starting to debate how soon a rate increase can be signalled, Governor Kuroda put that speculation to rest by stressing that the BoJ is not considering any hikes or tweaks to the current policy easing. The bank noted that risks to the inflation outlook are roughly balanced but risks to growth outlook is skewed to the downside. The Governor didn’t comment on specific FX levels, but said the current weak JPY is not bad for the economy. He also explained that it is not appropriate to stop the temporary inflation increases they are seeing by using monetary policy and that it’s too early to debate an exit from their current policy stance. The bank said that Japan will continue its expansive monetary policy unlike other G7s, and they are actively monitoring the economic impact from COVID-19 and won’t hesitate to add easing if necessary.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can be market-moving in the short-term, safe-haven flows are typically the more dominant factor. The market's overall risk tone has improved considerably following the pandemic with ongoing monetary and fiscal policy support paved the way for markets to expect a robust global economic recovery. However, as the Fed and other banks start to normalize, we do need to remember that it means those fiscal and monetary policy support are being reduced, which could mean a lot more volatility for markets in the weeks and months ahead. Even though that doesn’t mean our med-term bias for the JPY has changed, it simply means that we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create some fantastic directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in yield differentials, more specifically in strong moves in US10Y . However, like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the type of market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place with US02Y likely pushing higher while US10Y underperform. In this environment we do see some mild upside risks for the JPY, but we should not look at the influence from yields in isolation and weigh it up alongside underlying risk sentiment and price action in the USD of course.
4. CFTC Analysis
Even though the JPY’s med-term outlook remains bearish , the big net-shorts for both large specs and leveraged funds always increases odds of punchy mean reversion when risk sentiment deteriorates. Thus, equities & US10Y will remain very important drivers for the JPY in the weeks ahead.
5. The Week Ahead
In the week ahead, we once again expect one of the biggest influences for the JPY to be on geopolitics, with further escalations in tensions between Russia and Ukraine expected to see safe haven inflows into the JPY, and any de-escalations expected to see safe haven outflows from the JPY. Apart from risk sentiment, we’ll also be keeping a close eye on US10Y . With risk sentiment still shaky, and prospects of the economy being unscathed by the Fed’s hawkish plans looking slim right now, we still expect long-end yields to push lower in the weeks ahead, and if that happens it should prove supportive for the JPY (of course keeping equities in mind as well as downside in yields but upside in equities would see both a push and pull effect on the JPY).
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Despite STIR markets pricing in close to an 80% chance of a 25bsp hike, the BoC chose to leave rates unchanged at their Jan meeting. However, the bank removed its extraordinary forward guidance and said they now think the economic slack has been absorbed (previously expected to occur somewhere in the middle quarters of 2022). The bank also explained that they expect rates will need to rise based on the progress of inflation, and Gov Macklem explained their only reason for not hiking was uncertainty surrounding Omicron. The statement gave a clear signal that a March hike is on the table. Furthermore, on the balance sheet the bank delivered on expectations by noting they will likely exit the reinvestment phase as rates begin to rise. Even though 2022 inflation projections were upgraded, the bank also downgraded growth forecasts (which in our view remains a key reason why current STIR market expectations are not realistic). Thus, the meeting had both dovish and hawkish elements to it, and thus means we are still happy to hold to a neutral bias for the CAD.
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), strong global demand recovery, and of course ‘higher for longer’ than expected inflation. Even though Oil has traded to new 7-year highs, we think the current Russia/Ukraine tensions and recent tight capacity concerns are the biggest contributors to the upside as our cautious view going into Q1 & Q2 remain intact. The drivers keeping us cautious are A hawkish DM central banks targeting demand, slowing growth and inflation, lower inflation expectations (due to the Fed), a consensus that is very long oil (growing calls for $100 WTI). Recent geopolitical risks regarding Russia/Ukraine have been a key focus point for oil, but the increased chances of an Iran nuclear deal took some of the upside momentum away this past week. If Russia/Ukraine tensions stop sending oil prices higher, that tells us something about sentiment.
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
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 and optimistic to price in upside for the CAD, only to then see majority of it unwind. We think the CAD is setting up for a similar disappointment with money markets too aggressive on rate expectations for 2022.
5. The Week Ahead
Focus for the CAD is twofold this week with risk sentiment and Oil in focus. On risk sentiment and Oil, it’s a mixed bag for the CAD. Even though the oil market’s initial reactions to escalation and de-escalation were as expected, we did see the impact fading this week as some focus returned to the possibility of an Iran nuclear agreement came back on scene. We’ve initiated a new short on oil this past week (check out the rationale in the Trade Idea tab of the terminal), and if our rationale is correct and oil sees some downside in the sessions ahead, that opens up more room to the downside for the CAD as well. Then we have risk sentiment, where any further escalation is expected to be negative for risk sentiment (negative for the CAD) and any de-escalation is expected to be positive for risk sentiment (positive for the CAD). Just keep in mind that even though oil prices started to react less to geopolitical risks this past week doesn’t guarantee that it will continue to do so in the week ahead. However, if oil prices do react stronger to geopolitical risks that will make the CAD a tricky one to trade as oil and risk sentiment would move inverse to each other and mean the CAD could have both a push and pull effect on the CAD.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
No surprises from the BoJ at their Jan meeting. Despite some source reports which surprisingly suggested that the bank was starting to debate how soon a rate increase can be signalled, Governor Kuroda put that speculation to rest by stressing that the BoJ is not considering any hikes or tweaks to the current policy easing. The bank noted that risks to the inflation outlook are roughly balanced but risks to growth outlook is skewed to the downside. The Governor didn’t comment on specific FX levels, but said the current weak JPY is not bad for the economy. He also explained that it is not appropriate to stop the temporary inflation increases they are seeing by using monetary policy and that it’s too early to debate an exit from their current policy stance. The bank said that Japan will continue its expansive monetary policy unlike other G7s, and they are actively monitoring the economic impact from COVID-19 and won’t hesitate to add easing if necessary.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can be market-moving in the short-term, safe-haven flows are typically the more dominant factor. The market's overall risk tone has improved considerably following the pandemic with ongoing monetary and fiscal policy support paved the way for markets to expect a robust global economic recovery. However, as the Fed and other banks start to normalize, we do need to remember that it means those fiscal and monetary policy support are being reduced, which could mean a lot more volatility for markets in the weeks and months ahead. Even though that doesn’t mean our med-term bias for the JPY has changed, it simply means that we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create some fantastic directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in yield differentials, more specifically in strong moves in US10Y . However, like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the type of market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place with US02Y likely pushing higher while US10Y underperform. In this environment we do see some mild upside risks for the JPY, but we should not look at the influence from yields in isolation and weigh it up alongside underlying risk sentiment and price action in the USD of course.
4. CFTC Analysis
Even though the JPY’s med-term outlook remains bearish , the big net-shorts for both large specs and leveraged funds always increases odds of punchy mean reversion when risk sentiment deteriorates. Thus, equities & US10Y will remain very important drivers for the JPY in the weeks ahead.
5. The Week Ahead
In the week ahead, we once again expect one of the biggest influences for the JPY to be on geopolitics, with further escalations in tensions between Russia and Ukraine expected to see safe haven inflows into the JPY, and any de-escalations expected to see safe haven outflows from the JPY. Apart from risk sentiment, we’ll also be keeping a close eye on US10Y . With risk sentiment still shaky, and prospects of the economy being unscathed by the Fed’s hawkish plans looking slim right now, we still expect long-end yields to push lower in the weeks ahead, and if that happens it should prove supportive for the JPY (of course keeping equities in mind as well as downside in yields but upside in equities would see both a push and pull effect on the JPY).