AUD USD - FUNDAMENTAL DRIVERSAUD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
At their April meeting, the RBA took a slightly more hawkish stance by removing their reference to ‘patience’ in terms of policy tightening. With the bank taking a sanguine view of rising price pressures, the statement did reveal a growing concern for inflation with 10 references to ‘inflation’ in the statement. The bank explained that higher energy and commodity price could see a sizeable increase to inflation forecasts in the May report. In their Financial Stability report the bank urged borrowers to prepare for an increase in rates, which was a further signal from the bank. Even though the meeting showed a bank that is turning the page, the statement also revealed very similar conditionality such as incoming wage and inflation data. Following the meeting, markets have a bit of an overreaction by pricing in a >80% chance of a rate hike at the May meeting but was later pushed back to <30%. Given the importance of wage data, and since that is only release on the 18th of May, the most likely meeting for a first hike is the June meeting. Westpac investment bank agrees with our take with the bank expecting a 15bsp lift off in June, followed by 25bsp hikes in July, August, Oct and Nov. Even though this confirms our fundamental bullish bias, the >14 hikes priced by end 2023 means risks of lower repricing is building.
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
Quite strange positioning change for the AUD with Leverage Funds trimming net-shorts by a chunky amount but Asset Managers showing a whopping build up in net-short contracts. The shift in Asset Manager positioning could explain the reluctance of the AUD to make any real progress despite very positive China developments.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
In March the Fed delivered on a 25bsp hike as expected with Fed’s Bullard the only dissenter voting for a 50bsp hike. The Dot Plot saw a big upgrade from 3 hikes (Dec) to 7 hikes for 2022, with the FFR seen reaching 2.75%- 3.0% in 2023 before falling in 2024. They did however lower their neutral rate from 2.5% to 2.4% which were a negative. Inflation forecasts for 2022 were raised to 4.1% (previous 2.7%) but med-term inflation saw less aggressive upgrades. Even though the overall message and projections were hawkish, the fact that GDP estimates were lowered to 2.8% from 4.0% shows the Fed expects their actions to impact demand and also reflect some of the recent geopolitical uncertainties. The Fed didn’t share new details on QT but noted that the decision to start selling assets will be made at a coming meeting (markets consensus sees a July start as likely) and added that good progress in QT discussions means a May announcement is likely. During the presser the Chair expressed his view that the economy is doing really well and, should be more than able to withstand the incoming rate hikes (a very similar situation like we had in 4Q18). When asked whether 50bsp hikes could be on the table, the chair explained that the FOMC has not made decision to front-load hikes and will keep an eye on incoming inflation data to determine their policy actions going forward, but of course added that every incoming meeting was live. Overall, the Fed was hawkish, but due to very strong pre-positioning and close to peak hawkishness priced for STIR markets the meeting saw a ‘sell-the-fact’ reaction across major asset classes.
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
The main event for the week ahead will no doubt be the FOMC meeting, but we’ll also get ISM PMIs as well as the April jobs print coming our way. For the FOMC, we think the Fed has set themselves a very high hawkish bar going into the meeting. STIR markets are pricing in 3 back-to-back 50bsp hikes, as well as an earlier start to QT ($95bn p/m). On the language side, recent Fed speak has seen even the doves find their inner hawks by talking up very aggressive policy tightening. So, with all of that as the baseline going into the meeting, it means the Fed would need to hike 75bsp and up the expected QT pace to really surprise markets. With the USD and Yields at cycle highs and equities at cycle lows, that increases the chances of some sell-the-fact reactions. This would be our preferred strategy for the USD going into the week. Then we also have the data where the ISM PMI data will be closely watched for further clues of whether growth is slowing faster than expected. On the jobs side, the impact of the NFP will most likely be dictated by the outcome of the FOMC decision. If the Fed manages to surprise on the hawkish side (seems unlikely) a beat in jobs won’t do much to change that, but a miss can certainly do a lot to stir the pot (even more so if the Fed decision is interpreted as ‘less hawkish’.
