USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
A lot more hawkish than expected is how the Fed’s Dec decision can be summed up. The Fed doubled the pace of tapering to $30 billion per month which will see the QE program conclude by March 2022 as was widely expected. The big change came from the updated Summary of Econ Projections where the median dot plot pencilled in 3 hikes for the Fed next year (up from just shy of 1 hike projected just 3 months ago), confirming money market and 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 the taper has concluded. Another positive shift was Powell’s comments that the balance of goals means it could possibly raise rates before full employment has been met due to high inflation , and also stated that with inflation above target, they cannot wait too long to get to maximum employment with current levels of inflation described as a threat to full employment. The hawkish tilt even went so far that the bank started to discuss the balance sheet but said they didn't make any decisions on when the balance sheet would shrink. Even though the dots projected 3 hikes for 2022, the updated rate hike 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, with this recent meeting the Fed is now the second most hawkish CB after the RBNZ and should be supportive for the USD in the med-term . This past week’s meeting minutes also revealed that the bank has started discussing QT with majority of members thinking it’s appropriate to start QT soon after rate lift off which was a much more hawkish tilt than expected from the Fed.
2. Real Yields
With the hawkish tilt from the Fed, it should see breakeven inflation rates fall faster than US10Y as a more aggressive Fed should see med-term growth & inflation expectations fall. Rising real yields should be good for the USD as well and one to keep on the radar, especially after this weeks divergence.
3. Global Risk Outlook
What happens to growth and inflation this year will be key for the USD, not only growth and inflation in the US though but also on a global scale. The USD usually does bad in reflationary environments (where growth and inflation accelerates globally), while the USD usually does very well when growth and inflation decelerates globally). So, expectations that we are seeing a slowdown in both of them globally should be a positive input for the USD in the med-term . However, it also means there will be a lot of focus on the
incoming data to see how it develops.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +2289 with a net non-commercial position of +39078. With large specs net-longs close to 2019 highs and leverage funds USD longs also looking stretched, and with a lot of the Fed hawkishness arguably priced in, the USD has been looking vulnerable to some unwinding, which is what we saw this past week. Even though the Fed remains on a hawkish path (for now) and the USD remains bullish from a fundamental outlook point of view, with positioning where it is right now, any recovery in risk sentiment or bad economic data in the US relative to the rest of the world could continue to add some pressure on the Greenback in the short-term. However, it will take a lot to change the overall fundamental bullish outlook given what markets are expecting from 2022.
5. The Week Ahead
In the week ahead all eyes will be on US CPI as the main event. Even though there are expectations for inflation to slow, we are not there yet as participants are expecting yet another strong increase for the YY print with the headline expected to push above 7% and the Core measure expected well above 5%. Are these numbers that will scare the markets or the Fed, arguably not, because what more is there to price in. With markets already pricing in 3 hikes (a high probability of a first one in March) and pricing in higher probabilities of more than 3 hikes alongside QT, this week’s print needs to be something truly exceptional to see even more priced in. Thus, just like with NFP last week, we are anticipating more of a downside risk for the USD given the very high bar set by the markets. With everything that has been priced in for the Fed already, an unexpected beat can open up some decent downside in the USD. Just keep in mind that will be tactical trades as the fundamental outlook remains bullish for the USD.
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. Even though the bank still thinks inflation will ease from 2H22, they did drop the term "temporary" when referring to price pressures, similar to the Fed’s drop of 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 1Q22 hike, with market odds at roughly 50/50 for the Jan meeting. The recent Omicron restrictions is expected to hit growth in the first quarter, which means a hike in quarter 2 is more likely as the bank would arguably not be in too much of a hurry to turn overly aggressive given the divergence between the divergent government response to Omicron between the US and the BoC. Thus, we think the bank holds off with hikes until 2Q22, which means some of those aggressive policy bets (markets pricing in very close to 5 hikes for this year this past week) will arguably need to be pushed back and repriced.
2. Intermarket Analysis Considerations
Oil’s massive post-covid recovery has been impressive, driven by three drivers: supply & demand (OPEC’s production cuts); improving global economic outlook and improving oil demand outlook, even though slightly pushed back by Delta concerns; higher for longer than expected inflation. Even though Oil has recovered a lot of its recent downside and have proven our caution wrong, we are still cautious going into the first two quarters. The drivers keeping us cautious on oil right now is expectations of a
more hawkish Fed, slowing growth and inflation, and a possible supply surplus in 1Q22. If our concerns do materialize into downside for oil prices it should put pressure on the CAD. Recent supply constraints in Kazakhstan and Libya has aided oil this past week (alongside some higher inflation inputs), and if that continues it could provide continued short-term support for Oil though so worth keeping that in mind.
3. Global Risk Outlook
As a high-beta currency, the CAD benefited from the market's improving risk outlook coming out of the pandemic as participants moved out of safe-havens. As a pro-cyclical currency, the CAD enjoyed upside alongside other cyclical assets supported by reflation and post-recession recovery best. If expectations for the global economy remains positive the overall positive outlook for risk sentiment should be supportive for the CAD in the med-term, but recent short-term jitters are a timely reminder that risk sentiment is also a very important short-term driver.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -691 with a net non-commercial position of -11025. A lot of the previous froth priced into the CAD has arguably been reduced. However, given our concerns about Oil as well as the bar for an aggressive policy response from the BoC looking less certain, we do think there is chance of some additional repricing for the CAD going into 2022, which is why we’ve shifted our fundamental outlook to neutral from weak bullish.
5. The Week Ahead
In the week ahead the calendar is very slim for the CAD with no tier 1 data points. The good jobs print on Friday provided some additional upside for the CAD, which had a decent start to the new year. However, as employment is often seen as a lagging indicator, as well as the newly announced covid restrictions in Canada, we do think the growth and employment situation in 1Q22 is facing some deterioration. For now, the markets have seemed comfortable with that and the CAD has been very resilient, but we are not sure how long that can continue.
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
A lot more hawkish than expected is how the Fed’s Dec decision can be summed up. The Fed doubled the pace of tapering to $30 billion per month which will see the QE program conclude by March 2022 as was widely expected. The big change came from the updated Summary of Econ Projections where the median dot plot pencilled in 3 hikes for the Fed next year (up from just shy of 1 hike projected just 3 months ago), confirming money market and 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 the taper has concluded. Another positive shift was Powell’s comments that the balance of goals means it could possibly raise rates before full employment has been met due to high inflation , and also stated that with inflation above target, they cannot wait too long to get to maximum employment with current levels of inflation described as a threat to full employment. The hawkish tilt even went so far that the bank started to discuss the balance sheet but said they didn't make any decisions on when the balance sheet would shrink. Even though the dots projected 3 hikes for 2022, the updated rate hike 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, with this recent meeting the Fed is now the second most hawkish CB after the RBNZ and should be supportive for the USD in the med-term . This past week’s meeting minutes also revealed that the bank has started discussing QT with majority of members thinking it’s appropriate to start QT soon after rate lift off which was a much more hawkish tilt than expected from the Fed.
2. Real Yields
With the hawkish tilt from the Fed, it should see breakeven inflation rates fall faster than US10Y as a more aggressive Fed should see med-term growth & inflation expectations fall. Rising real yields should be good for the USD as well and one to keep on the radar, especially after this weeks divergence.
3. Global Risk Outlook
What happens to growth and inflation this year will be key for the USD, not only growth and inflation in the US though but also on a global scale. The USD usually does bad in reflationary environments (where growth and inflation accelerates globally), while the USD usually does very well when growth and inflation decelerates globally). So, expectations that we are seeing a slowdown in both of them globally should be a positive input for the USD in the med-term . However, it also means there will be a lot of focus on the
incoming data to see how it develops.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +2289 with a net non-commercial position of +39078. With large specs net-longs close to 2019 highs and leverage funds USD longs also looking stretched, and with a lot of the Fed hawkishness arguably priced in, the USD has been looking vulnerable to some unwinding, which is what we saw this past week. Even though the Fed remains on a hawkish path (for now) and the USD remains bullish from a fundamental outlook point of view, with positioning where it is right now, any recovery in risk sentiment or bad economic data in the US relative to the rest of the world could continue to add some pressure on the Greenback in the short-term. However, it will take a lot to change the overall fundamental bullish outlook given what markets are expecting from 2022.
5. The Week Ahead
In the week ahead all eyes will be on US CPI as the main event. Even though there are expectations for inflation to slow, we are not there yet as participants are expecting yet another strong increase for the YY print with the headline expected to push above 7% and the Core measure expected well above 5%. Are these numbers that will scare the markets or the Fed, arguably not, because what more is there to price in. With markets already pricing in 3 hikes (a high probability of a first one in March) and pricing in higher probabilities of more than 3 hikes alongside QT, this week’s print needs to be something truly exceptional to see even more priced in. Thus, just like with NFP last week, we are anticipating more of a downside risk for the USD given the very high bar set by the markets. With everything that has been priced in for the Fed already, an unexpected beat can open up some decent downside in the USD. Just keep in mind that will be tactical trades as the fundamental outlook remains bullish for the USD.
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. Even though the bank still thinks inflation will ease from 2H22, they did drop the term "temporary" when referring to price pressures, similar to the Fed’s drop of 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 1Q22 hike, with market odds at roughly 50/50 for the Jan meeting. The recent Omicron restrictions is expected to hit growth in the first quarter, which means a hike in quarter 2 is more likely as the bank would arguably not be in too much of a hurry to turn overly aggressive given the divergence between the divergent government response to Omicron between the US and the BoC. Thus, we think the bank holds off with hikes until 2Q22, which means some of those aggressive policy bets (markets pricing in very close to 5 hikes for this year this past week) will arguably need to be pushed back and repriced.
2. Intermarket Analysis Considerations
Oil’s massive post-covid recovery has been impressive, driven by three drivers: supply & demand (OPEC’s production cuts); improving global economic outlook and improving oil demand outlook, even though slightly pushed back by Delta concerns; higher for longer than expected inflation. Even though Oil has recovered a lot of its recent downside and have proven our caution wrong, we are still cautious going into the first two quarters. The drivers keeping us cautious on oil right now is expectations of a
more hawkish Fed, slowing growth and inflation, and a possible supply surplus in 1Q22. If our concerns do materialize into downside for oil prices it should put pressure on the CAD. Recent supply constraints in Kazakhstan and Libya has aided oil this past week (alongside some higher inflation inputs), and if that continues it could provide continued short-term support for Oil though so worth keeping that in mind.
3. Global Risk Outlook
As a high-beta currency, the CAD benefited from the market's improving risk outlook coming out of the pandemic as participants moved out of safe-havens. As a pro-cyclical currency, the CAD enjoyed upside alongside other cyclical assets supported by reflation and post-recession recovery best. If expectations for the global economy remains positive the overall positive outlook for risk sentiment should be supportive for the CAD in the med-term, but recent short-term jitters are a timely reminder that risk sentiment is also a very important short-term driver.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -691 with a net non-commercial position of -11025. A lot of the previous froth priced into the CAD has arguably been reduced. However, given our concerns about Oil as well as the bar for an aggressive policy response from the BoC looking less certain, we do think there is chance of some additional repricing for the CAD going into 2022, which is why we’ve shifted our fundamental outlook to neutral from weak bullish.
5. The Week Ahead
In the week ahead the calendar is very slim for the CAD with no tier 1 data points. The good jobs print on Friday provided some additional upside for the CAD, which had a decent start to the new year. However, as employment is often seen as a lagging indicator, as well as the newly announced covid restrictions in Canada, we do think the growth and employment situation in 1Q22 is facing some deterioration. For now, the markets have seemed comfortable with that and the CAD has been very resilient, but we are not sure how long that can continue.