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 the bag holders of massive net-short positions on the AUD finally saw some punchy unwinds last week, the most recent data updated until Tuesday showed an increase in net-shorts again for Large Specs and Leveraged Funds. For weeks now we’ve been very surprised by the reluctance of big net-short positions to unwind. Given all the recent positive developments for the AUD we would have expected a bigger unwind already. Last week’s increase in shorts still paints current positioning as a contrarian indicator for AUD upside.
5. The Week Ahead
The week ahead will be extremely quiet on the data from for the AUD. Which means the overall focus will fall to China, commodities and risk sentiment. The announcements from the CCP two weeks ago saw immediate support for Chinese equities and also boosted Aussie commodity prices which in turn supported the AUD. Thus, any continued good news from China will be a key catalyst to watch for the antipodean. This is closely linked to commodities as well, where Australia’s key commodity exports Iron Ore, LNG and Coal have remained well supported, and any news or developments that keep them supported or cause them to drop will be very important for the AUD. Over the weekend we heard of additional lockdown measures in China, which will be another focus point for the AUD in the week ahead as any expectations that lockdowns will alter the expected recovery will be a negative. As always risk sentiment remains a focus for the AUD, where any major developments between Russia and Ukraine can have an impact, but commodities have been the dominant driver for the AUD in recent weeks so the sensitivity to pure risk flows has been less intense than usual. Our preferred way of expressing expected strength for the AUD is versus the CAD (check out recent trade ideas for information on why). It’s important to note that price action has been very one-side to the upside and is looking rather stretched so some short-term corrective price action should not be surprising without any key catalysts or drivers.
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: [1] Synchronised policy tightening from DM central banks targeting demand, [2] slowing growth and inflation, [3] a consensus that is very long oil (growing calls for $100 WTI), [5] very steep backwardation futures curve which usually sees negative forward returns, [6] 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: 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 the bag holders of massive net-short positions on the AUD finally saw some punchy unwinds last week, the most recent data updated until Tuesday showed an increase in net-shorts again for Large Specs and Leveraged Funds. For weeks now we’ve been very surprised by the reluctance of big net-short positions to unwind. Given all the recent positive developments for the AUD we would have expected a bigger unwind already. Last week’s increase in shorts still paints current positioning as a contrarian indicator for AUD upside.
5. The Week Ahead
The week ahead will be extremely quiet on the data from for the AUD. Which means the overall focus will fall to China, commodities and risk sentiment. The announcements from the CCP two weeks ago saw immediate support for Chinese equities and also boosted Aussie commodity prices which in turn supported the AUD. Thus, any continued good news from China will be a key catalyst to watch for the antipodean. This is closely linked to commodities as well, where Australia’s key commodity exports Iron Ore, LNG and Coal have remained well supported, and any news or developments that keep them supported or cause them to drop will be very important for the AUD. Over the weekend we heard of additional lockdown measures in China, which will be another focus point for the AUD in the week ahead as any expectations that lockdowns will alter the expected recovery will be a negative. As always risk sentiment remains a focus for the AUD, where any major developments between Russia and Ukraine can have an impact, but commodities have been the dominant driver for the AUD in recent weeks so the sensitivity to pure risk flows has been less intense than usual. Our preferred way of expressing expected strength for the AUD is versus the CAD (check out recent trade ideas for information on why). It’s important to note that price action has been very one-side to the upside and is looking rather stretched so some short-term corrective price action should not be surprising without any key catalysts or drivers.
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: [1] Synchronised policy tightening from DM central banks targeting demand, [2] slowing growth and inflation, [3] a consensus that is very long oil (growing calls for $100 WTI), [5] very steep backwardation futures curve which usually sees negative forward returns, [6] 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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