AUD CAD - FUNDAMENTAL DRIVERS
AUD
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
At their March meeting, the bank didn’t do much to surprise markets and stuck to a similar script compared to the previous meeting, with the exception of adding the Russia/Ukraine war as a major new source of uncertainty. While Unemployment is at 4.2% and expected to be below 4% throughout 2023, and with Inflation above the middle of the target range and expected to rise to 3.25 this year and stay at 2.75% throughout 2023, the continues dovish façade is getting a little embarrassing for the bank. Even though wage growth failed to surprise higher, consensus still expects it to reach 3% in Q2 and well above 3% in Q3, and once the 3% level is reached the RBA would have complete ran out of reasons to stay dovish. It’s clear that markets are looking straight through this though as STIR markets, bond yields and the AUD failed to see any real downside after the meeting and continued higher after a very brief and small dip lower. For now, the bank stays dovish, but the longer they stay in denial the longer the chances of a more aggressive hawkish pivot later.
2. Idiosyncratic Drivers & Intermarket Analysis
Apart from the RBA, there are 4 drivers we’re watching for the med-term outlook: [1] Recovery – unlike other nations where growth & inflation is expected to slow, Australia is expected to see a solid recovery, also thanks to expected recovery in China [2] China – With the PBoC stepping up stimulus & expectations of further fiscal support 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 [3] Commodities – Australia’s biggest commodities Iron Ore (31%), Coal (14%) and LNG (10%) keep grinding higher for various reasons, one being China’s expected recovery and the other the energy and inflation concerns. As long as these commodities are supported, they should continue to support the AUD.
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
Even though bearish AUD positioning saw big unwinds three weeks ago, large specs and leveraged funds still hold stretched shorts (within bottom 20% of net-shorts going back to 2007). This still points to the possibility of short squeezes for the AUD if we see positive sentiment shifts so worth keeping in mind going into the RBA. However, price action has been very one-sided in recent weeks so we are treading carefully with new longs.
5. The Week Ahead
In the week ahead the biggest focus for the AUD will be the RBA policy decision. Markets are expecting the bank to offer no real surprises and use the meeting as a placeholder until we get the election out of the way and until the bank has seen more inflation and wage growth data for Q2. Given the very aggressive STIR market pricing for 2022 (over 200bsp of tightening already priced), as well as the solid upside we’ve seen from the terms of trade boost, there is arguably some downside risks for the AUD if the RBA sticks to their dovish script. The markets have of course ignored their dovish tones, and even though a continued dovish tone won’t change market’s expectations of hikes this year, it could push out some of the dates as >200bsp seems close to impossible right now (same can be said for most major central bank pricing right now though). Apart from the RBA focus will also be on China and commodities. For China, the Caixin Services PMI will be interesting after the big drop in Mfg last week, where a negative print could weigh on the AUD and a positive print be supportive. Any further stimulus promises or measures from the CCP or PBoC is also worth the watch. For commodities, the geopolitical tensions and support from China has seen key Australian commodity exports like Iron Ore, LNG and Coal remain well supported, which has given Australia’s terms of trade quite a boost. As commodities have been supported by geopolitical stress and stimulus hopes from China, anything that dents that optimism and sees some mean reversion in commodity moves will be important to watch for the AUD. This also means that the AUD might counterintuitively trade mixed on geopolitical de-escalations depending on how commodities react.
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The BoC did not surprise at their March meeting by hiking rates to 0.50% from 0.25% and continuing the reinvestment phase regarding asset purchases. The bank noted that the Russia/Ukraine war was a new major uncertainty for the economy and that as a result inflation is now expected to be higher in the near-term. They were optimistic about the growth outlook though and reiterated that it expects further interest rate rises will be needed. On the QT side, Gov Macklem noted that around 40% of the bank's bond holdings were due to mature within two years, and suggested that balance sheet could shrink quickly, and also added that they will
discuss ending the reinvestment phase and starting QT at the April meeting. The Governor also said he didn’t rule out the potential for 50bsp rate rises as oil is putting upside pressure on CPI , noting that oil prices around $110 per barrel could add another percentage point to inflation . With markets implying close to another 8 hikes this year, we remain cautious on the currency as a slowing US and Canadian economy means the bank could struggle to maintain its current hawkish path in the weeks and months ahead.
2. Intermarket Analysis Considerations
Oil’s impressive post-covid recovery has been driven by factors such as supply & demand (OPEC’s production cuts), strong global demand recovery, and of course ‘higher for longer’ inflation . The geopolitical crisis saw upside in WTI that reached levels last seen since in 2008. At these levels the risk to demand destruction and stagflation is high which means we remain cautious of oil in the med-term . Reason for that view is: Synchronised policy tightening from DM central banks targeting demand, slowing growth, consensus that is very long oil , steep backwardation curve (usually sees negative forward returns), heightened implied volatility . Even though we remain cautious on oil , the geopolitical risks remains a key focus for oil and thus for Petro-currencies like the CAD and NOK (even though the CAD-Oil correlation has been hit and miss).
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
Very bullish positioning signals with large specs and leveraged funds trimming shorts and asset managers adding a big 20K net-longs. It seems markets are warning to the idea of a 50bsp hike from the BoC after recent BoC comments. We continue to think recent price action is potentially setting up a similar path compared to April and Oct 2021 where markets were too aggressive and optimistic to price in upside for the CAD, only to then see majority of it unwind later. We’ll use any outsized strength for AUDCAD long opportunities.
5. The Week Ahead
There are two key economic releases in focus for the CAD this week with the Business Outlook Survey coming up on Monday and the Jobs report on Friday. With recent comments from the BoC turning up the hawkish rhetoric, the data this week will be eyed to get a better sense of whether the BoC will move by 25bsp or 50bsp at their next meeting. For the Business Outlook Survey markets participants are expecting a solid price due to increased commodity prices after the war broke out. Furthermore, the markets are looking for a continuation in the job gains, even though we’ve explained before that the previous print wasn’t all that it was made out to be with net-job gains not as spectacular as some made it out to be. After Friday’s solid US NFP, and after the recent BoC comments the jobs print and the Business Outlook Survey could be enough to push STIR markets over the edge and start pricing in a 50bsp. Even though that can certainly be positive for currency, we don’t have appetite to chase the CAD higher as it’s seen a lot of one-sided upsides which does make it vulnerable to correction. Our preferred longs are AUDCAD and USDCAD but waiting for a catalyst to trade looks like the best course of action right now.
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
At their March meeting, the bank didn’t do much to surprise markets and stuck to a similar script compared to the previous meeting, with the exception of adding the Russia/Ukraine war as a major new source of uncertainty. While Unemployment is at 4.2% and expected to be below 4% throughout 2023, and with Inflation above the middle of the target range and expected to rise to 3.25 this year and stay at 2.75% throughout 2023, the continues dovish façade is getting a little embarrassing for the bank. Even though wage growth failed to surprise higher, consensus still expects it to reach 3% in Q2 and well above 3% in Q3, and once the 3% level is reached the RBA would have complete ran out of reasons to stay dovish. It’s clear that markets are looking straight through this though as STIR markets, bond yields and the AUD failed to see any real downside after the meeting and continued higher after a very brief and small dip lower. For now, the bank stays dovish, but the longer they stay in denial the longer the chances of a more aggressive hawkish pivot later.
2. Idiosyncratic Drivers & Intermarket Analysis
Apart from the RBA, there are 4 drivers we’re watching for the med-term outlook: [1] Recovery – unlike other nations where growth & inflation is expected to slow, Australia is expected to see a solid recovery, also thanks to expected recovery in China [2] China – With the PBoC stepping up stimulus & expectations of further fiscal support 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 [3] Commodities – Australia’s biggest commodities Iron Ore (31%), Coal (14%) and LNG (10%) keep grinding higher for various reasons, one being China’s expected recovery and the other the energy and inflation concerns. As long as these commodities are supported, they should continue to support the AUD.
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
Even though bearish AUD positioning saw big unwinds three weeks ago, large specs and leveraged funds still hold stretched shorts (within bottom 20% of net-shorts going back to 2007). This still points to the possibility of short squeezes for the AUD if we see positive sentiment shifts so worth keeping in mind going into the RBA. However, price action has been very one-sided in recent weeks so we are treading carefully with new longs.
5. The Week Ahead
In the week ahead the biggest focus for the AUD will be the RBA policy decision. Markets are expecting the bank to offer no real surprises and use the meeting as a placeholder until we get the election out of the way and until the bank has seen more inflation and wage growth data for Q2. Given the very aggressive STIR market pricing for 2022 (over 200bsp of tightening already priced), as well as the solid upside we’ve seen from the terms of trade boost, there is arguably some downside risks for the AUD if the RBA sticks to their dovish script. The markets have of course ignored their dovish tones, and even though a continued dovish tone won’t change market’s expectations of hikes this year, it could push out some of the dates as >200bsp seems close to impossible right now (same can be said for most major central bank pricing right now though). Apart from the RBA focus will also be on China and commodities. For China, the Caixin Services PMI will be interesting after the big drop in Mfg last week, where a negative print could weigh on the AUD and a positive print be supportive. Any further stimulus promises or measures from the CCP or PBoC is also worth the watch. For commodities, the geopolitical tensions and support from China has seen key Australian commodity exports like Iron Ore, LNG and Coal remain well supported, which has given Australia’s terms of trade quite a boost. As commodities have been supported by geopolitical stress and stimulus hopes from China, anything that dents that optimism and sees some mean reversion in commodity moves will be important to watch for the AUD. This also means that the AUD might counterintuitively trade mixed on geopolitical de-escalations depending on how commodities react.
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The BoC did not surprise at their March meeting by hiking rates to 0.50% from 0.25% and continuing the reinvestment phase regarding asset purchases. The bank noted that the Russia/Ukraine war was a new major uncertainty for the economy and that as a result inflation is now expected to be higher in the near-term. They were optimistic about the growth outlook though and reiterated that it expects further interest rate rises will be needed. On the QT side, Gov Macklem noted that around 40% of the bank's bond holdings were due to mature within two years, and suggested that balance sheet could shrink quickly, and also added that they will
discuss ending the reinvestment phase and starting QT at the April meeting. The Governor also said he didn’t rule out the potential for 50bsp rate rises as oil is putting upside pressure on CPI , noting that oil prices around $110 per barrel could add another percentage point to inflation . With markets implying close to another 8 hikes this year, we remain cautious on the currency as a slowing US and Canadian economy means the bank could struggle to maintain its current hawkish path in the weeks and months ahead.
2. Intermarket Analysis Considerations
Oil’s impressive post-covid recovery has been driven by factors such as supply & demand (OPEC’s production cuts), strong global demand recovery, and of course ‘higher for longer’ inflation . The geopolitical crisis saw upside in WTI that reached levels last seen since in 2008. At these levels the risk to demand destruction and stagflation is high which means we remain cautious of oil in the med-term . Reason for that view is: Synchronised policy tightening from DM central banks targeting demand, slowing growth, consensus that is very long oil , steep backwardation curve (usually sees negative forward returns), heightened implied volatility . Even though we remain cautious on oil , the geopolitical risks remains a key focus for oil and thus for Petro-currencies like the CAD and NOK (even though the CAD-Oil correlation has been hit and miss).
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
Very bullish positioning signals with large specs and leveraged funds trimming shorts and asset managers adding a big 20K net-longs. It seems markets are warning to the idea of a 50bsp hike from the BoC after recent BoC comments. We continue to think recent price action is potentially setting up a similar path compared to April and Oct 2021 where markets were too aggressive and optimistic to price in upside for the CAD, only to then see majority of it unwind later. We’ll use any outsized strength for AUDCAD long opportunities.
5. The Week Ahead
There are two key economic releases in focus for the CAD this week with the Business Outlook Survey coming up on Monday and the Jobs report on Friday. With recent comments from the BoC turning up the hawkish rhetoric, the data this week will be eyed to get a better sense of whether the BoC will move by 25bsp or 50bsp at their next meeting. For the Business Outlook Survey markets participants are expecting a solid price due to increased commodity prices after the war broke out. Furthermore, the markets are looking for a continuation in the job gains, even though we’ve explained before that the previous print wasn’t all that it was made out to be with net-job gains not as spectacular as some made it out to be. After Friday’s solid US NFP, and after the recent BoC comments the jobs print and the Business Outlook Survey could be enough to push STIR markets over the edge and start pricing in a 50bsp. Even though that can certainly be positive for currency, we don’t have appetite to chase the CAD higher as it’s seen a lot of one-sided upsides which does make it vulnerable to correction. Our preferred longs are AUDCAD and USDCAD but waiting for a catalyst to trade looks like the best course of action right now.
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