USD CAD - FUNDAMENTAL DRIVERS
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 slow (disinflation) and depreciates when growth & inflation accelerates (reflation). Thus, current expectations of a cyclical slowdown (and possible stagflation) are good 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 tightening into a slowdown. If growth data slows and the Fed stays hawkish it’s a positive for the USD, if the Fed pivots dovish that’ll be a negative for the USD.
3. CFTC Analysis
Overall net-long positioning was a risk for the USD going into the March FOMC, where due to very strong performance in recent weeks, there was a high bar for a hawkish Fed to see a sustained rally in the USD. Participants are mixed in their allocations with Large Specs and Asset Managers still holding big net-longs, but leverage funds continue to increase shorts. The USD is in a tough spot right now, as short-term the odds of some unwind likely as markets now price in >8 hikes by Dec, but med-term bullish drivers have not changed.
4. The Week Ahead
It’s the first Friday of the new month which means it’s US jobs week, and the data will be eyed as it will give further insights into how fast growth is slowing, and whether the data shows further signs of a possible stagflation environment in the weeks ahead. Apart from NFP, we also have PCE data in focus, as well as important growth input data such as Consumer Confidence and Personal Income and Consumption. The Dollar usually has an inverse correlation to global growth and usually has a positive expected return during periods of disinflation and stagflation (keep in mind that forward returns are much stronger for periods of disinflation compared to stagflation). Thus, if growth data or employment data shows bigger-than-expected downside while inflation data shows bigger-than-expected upside should see further yield curve flattening which should be supportive for the USD. We’ll also be keeping an eye on further geopolitical developments, where the USD’s safe haven status will play a role in possible short-term directional moves as well. It’s worth noting that the USD is still close to cycle highs and with STIR markets now pricing in >8 hikes and odds of a 50bsp hike close to 80% it does mean the USD could be vulnerable to corrective price action as it has not been able to take advantage of any meaningful upside alongside yields or STIR markets. When something doesn’t rally on positive news that usually tells us something, which in this case potentially shows us that a lot of upside has been priced in for the USD and if anything happens that reduces STIR market pricing it could have a asymmetric reaction to the downside.
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 oil , noting that oil prices around $110 per barrel could add another percentage point to inflation . With markets implying close to another 5 hikes this year, we remain cautious on the currency as a slowing US and Canadian economy means the bank should struggle to maintain its current hawkish path in the weeks and months ahead.
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 . The geopolitical crisis the world is facing right now have opened up a big push higher in WTI, trading at levels last seen since 2008. With oil prices at these levels the risk to demand destruction and stagflation is higher than ever and 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 and inflation , a consensus that is very long oil (growing calls for $100 WTI), 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. OPEC+ will also be in focus next week but the cartel is not expected to announce any changes to their output plans.
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
Large Specs (big increase in net-shorts) and Asset Managers (big increase in net-longs) are at odds with recent positioning changes. We continue to 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 too aggressive and optimistic to price in upside for the CAD, only to then see majority of it unwind. However, oil prices, inflation and recent hawkish BoC comments remain in focus as keys intermarket drivers, albeit the oil correlation has been hit and miss.
5. The Week Ahead
The data schedule is feather light for the CAD this week. We continue to remain cautious on the CAD and despite continued calls for a roaring economy we do not share the optimism. The recent jobs print, even though it was positive at face value, was not that impressive when incorporating the Omicron-related drop. Furthermore, even though inflation were higher than expected, it wasn’t the type of upside scare we’ve seen in other economies like the US, UK and EU. The CAD jolted higher on Friday with strong language from the BoC deputy governor who talked up more aggressive policy in the face of higher inflation . However, they also shared our concerns by noting that the levels of current debt levels will make aggressive hikes problematic due to current debt levels. If expectations for a slowdown in the US and Canadian economies are correct, it increases the probability that the BoC will need to turn dovish in coming months and means we doubt whether the bank will be able to get close to the >8 hikes priced in by STIR markets. Thus, we continue to look for upside in the AUDCAD on a med-term basis, but in the short-term we are cautious of some corrective price action after the one-sided upside we saw recently, so just keep that in mind.
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 slow (disinflation) and depreciates when growth & inflation accelerates (reflation). Thus, current expectations of a cyclical slowdown (and possible stagflation) are good 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 tightening into a slowdown. If growth data slows and the Fed stays hawkish it’s a positive for the USD, if the Fed pivots dovish that’ll be a negative for the USD.
3. CFTC Analysis
Overall net-long positioning was a risk for the USD going into the March FOMC, where due to very strong performance in recent weeks, there was a high bar for a hawkish Fed to see a sustained rally in the USD. Participants are mixed in their allocations with Large Specs and Asset Managers still holding big net-longs, but leverage funds continue to increase shorts. The USD is in a tough spot right now, as short-term the odds of some unwind likely as markets now price in >8 hikes by Dec, but med-term bullish drivers have not changed.
4. The Week Ahead
It’s the first Friday of the new month which means it’s US jobs week, and the data will be eyed as it will give further insights into how fast growth is slowing, and whether the data shows further signs of a possible stagflation environment in the weeks ahead. Apart from NFP, we also have PCE data in focus, as well as important growth input data such as Consumer Confidence and Personal Income and Consumption. The Dollar usually has an inverse correlation to global growth and usually has a positive expected return during periods of disinflation and stagflation (keep in mind that forward returns are much stronger for periods of disinflation compared to stagflation). Thus, if growth data or employment data shows bigger-than-expected downside while inflation data shows bigger-than-expected upside should see further yield curve flattening which should be supportive for the USD. We’ll also be keeping an eye on further geopolitical developments, where the USD’s safe haven status will play a role in possible short-term directional moves as well. It’s worth noting that the USD is still close to cycle highs and with STIR markets now pricing in >8 hikes and odds of a 50bsp hike close to 80% it does mean the USD could be vulnerable to corrective price action as it has not been able to take advantage of any meaningful upside alongside yields or STIR markets. When something doesn’t rally on positive news that usually tells us something, which in this case potentially shows us that a lot of upside has been priced in for the USD and if anything happens that reduces STIR market pricing it could have a asymmetric reaction to the downside.
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 oil , noting that oil prices around $110 per barrel could add another percentage point to inflation . With markets implying close to another 5 hikes this year, we remain cautious on the currency as a slowing US and Canadian economy means the bank should struggle to maintain its current hawkish path in the weeks and months ahead.
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 . The geopolitical crisis the world is facing right now have opened up a big push higher in WTI, trading at levels last seen since 2008. With oil prices at these levels the risk to demand destruction and stagflation is higher than ever and 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 and inflation , a consensus that is very long oil (growing calls for $100 WTI), 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. OPEC+ will also be in focus next week but the cartel is not expected to announce any changes to their output plans.
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
Large Specs (big increase in net-shorts) and Asset Managers (big increase in net-longs) are at odds with recent positioning changes. We continue to 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 too aggressive and optimistic to price in upside for the CAD, only to then see majority of it unwind. However, oil prices, inflation and recent hawkish BoC comments remain in focus as keys intermarket drivers, albeit the oil correlation has been hit and miss.
5. The Week Ahead
The data schedule is feather light for the CAD this week. We continue to remain cautious on the CAD and despite continued calls for a roaring economy we do not share the optimism. The recent jobs print, even though it was positive at face value, was not that impressive when incorporating the Omicron-related drop. Furthermore, even though inflation were higher than expected, it wasn’t the type of upside scare we’ve seen in other economies like the US, UK and EU. The CAD jolted higher on Friday with strong language from the BoC deputy governor who talked up more aggressive policy in the face of higher inflation . However, they also shared our concerns by noting that the levels of current debt levels will make aggressive hikes problematic due to current debt levels. If expectations for a slowdown in the US and Canadian economies are correct, it increases the probability that the BoC will need to turn dovish in coming months and means we doubt whether the bank will be able to get close to the >8 hikes priced in by STIR markets. Thus, we continue to look for upside in the AUDCAD on a med-term basis, but in the short-term we are cautious of some corrective price action after the one-sided upside we saw recently, so just keep that in mind.
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