AUD CAD - FUNDAMENTAL DRIVERSAUD
FUNDAMENTAL BIAS: WEAK BULLISH
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: Recovery – unlike other nations where growth & inflation is expected to slow, Australia is expected to see a solid post-covid recovery China – With the PBoC stepping up stimulus & expectations of further fiscal support expected in 1H22, the projected recovery in China bodes well for Australia as China makes up close to 40% of Australian exports. However, the AUKUS defence pact could see retaliation against Aussie goods and is worth keeping on the radar. Commodities – Iron Ore (24% of exports) and Coal (18% of exports) keep grinding higher and if China’s recovery starts to build some momentum, they should remain supported.
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.
5. The Week Ahead
Right now, we think the Australian economy is well-placed compared to its peers as its economic is expected to recover alongside that of China (after going through a slowdown) just as other major economies are expected to slow down. Even though markets have been pricing in a steep rate path for the RBA, we still think the large netshort positioning means lots of catch-up potential for the AUD when the RBA eventually turns hawkish. Even though last week’s wage index printed slightly below target, market consensus still looks for 3% in Q2 and 3.5% by Q3, which means as long as inflation stays high (no expectation for that to slow as yet) and the labour market remains tight and growth keeps on recovering, the RBA should be next in line to tilt more hawkish, with a hike in rates very likely by the middle of the year. Despite the geopolitical risks these past few weeks, the AUD has remained very resilient, a good sign for our med-term upside expectations. This week we have the RBA, and even though they are not expected to shift their tone drastically just yet, the market has largely ignored the dovish language recently, and we would expect them to do so in the week ahead as well. For the week ahead, we have preliminarily shifted our currency bias for the AUD from neutral to bullish, but keep in mind that the AUD has seen a few weeks of solid gains recently, which means seeing some reprieve lower should not be much of a surprise. However, we are looking for any decent moves lower in the AUD as opportunities to get back in on the long side. However, given the weekend’s news of additional sanctions, this upcoming week is set to be very risk sentiment driven so keep that in mind as well.
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. We maintain a view that thinks there is greater risks of med-term downside due to: Synchronised policy tightening from 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), a very steep backwardation futures curve which usually sees negative forward returns, heightened implied volatility. However, recent geopolitical risks have been a key focus point for oil and means escalation and de-escalation will be important to watch.
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. However, with almost 3 weeks of straight downside we do want to be mindful of the possibility of some short-term upside, especially if the weekend sanction news sees further Oil upside.
5. The Week Ahead
Focus for the CAD is threefold this week with risk sentiment, Oil and the BoC 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. With risk sentiment, 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. For the BoC, the market continues to price in a 100% probability of a 25bsp hike this upcoming week. We think there is a real risk that the decision is poised to be a ‘dovish’ hike, as the bank will want to keep the hiking going due to inflation but would want to leave some optionality by recognizing the potential damage the recent border protests could pose for growth and consumer sentiment in general. There is also the Russia/Ukraine war which complicates things for central banks right now, and given that uncertainty it would make sense for the BoC to walk back some of the aggressive pricing embedded into STIR markets.
