After last week's surprising CPI developments, it appears that we are now leaning towards the idea that there might be an increased likelihood of another BoC hike in October, with market expectations shifting significantly (from a mere 30% prior to now exceeding 50%). However, I believe it's important to keep a watchful eye on this week's GDP data, which I anticipate could potentially temper these expectations. Friday will bring us July GDP figures (with consensus at 0.1% and my outlook slightly more conservative at 0.0%), along with initial Statscan insights into August.

My perspective aligns with RBC's forecast of a -0.5% Q3 projection. While employment and hours worked did rebound in August, it's worth noting that housing markets have been displaying signs of cooling, and consumer spending on non-essential items continues to show sluggishness. Additionally, this week, we will receive Q2 CA population estimates, a closely monitored metric given the robust y/y increase seen in Q1, which was the most substantial growth since the 1950s. While population growth can be seen as a positive factor for economic expansion and the housing sector, it's essential to remember that, within the BoC's framework, it can also introduce dynamics that affect the labor market and supply side.

Reflecting on my CAD framework, it suggests a negative residual of 0.7% last week, indicating that USD/CAD may have weakened more than anticipated by usual drivers. I see potential for this to correct in the coming week, especially with the current downward trend in USD/CAD showing signs of fatigue and the supporting trendline, originating from the July lows, remaining intact. Any further softness in the equity market would be a contributing factor.

It's noteworthy that substantial buying pressure of US equity futures by asset managers in the previous week, with USD23 billion in new long positions. These positions are already showing signs of vulnerability to potential liquidation.

In sum, I would recommend keeping a cautious and observant stance, particularly in light of the evolving economic landscape and its potential impact on the markets.

LONG ON USDCAD

I'm recommending a new short position on the GBP/CAD currency pair as we approach the upcoming Bank of England (BoE) policy meeting scheduled for next week. At the moment, the pair is trading slightly above a key support level represented by the 200-day moving average, situated around 1.66 key level as well. If this support level is breached, it could potentially lead to a further decline in the exchange rate, possibly revisiting the lows witnessed earlier this year near the 1.6000 level.

I've chosen to take this short position based on my recent shift towards a more pessimistic short-term outlook for the British Pound (GBP). This shift in perspective has been influenced by the less hawkish statements made by BoE officials, which have tempered expectations for additional interest rate hikes beyond the upcoming Monetary Policy Committee (MPC) meeting. This shift aligns with my own projections, which anticipate only one more rate hike from the BoE, ultimately resulting in a peak policy rate of 5.50%.

Furthermore, recent economic activity data suggests that growth in the third quarter may turn out to be considerably weaker than initially anticipated. Initially, the BoE had forecasted growth of 0.4%, but following a weak start in July (-0.5%), it now seems unlikely. If the BoE follows the path of the European Central Bank (ECB) and signals increased confidence that interest rates are nearing their peak, this could trigger a similar sell-off for the GBP during this week and the upcoming week.

On the other side of this trade, the Canadian Dollar (CAD) has not fully benefited from the recent rebound in energy prices over the past few months. My short-valuation model indicates that the CAD is undervalued, and there is room for the CAD to strengthen and catch up. Oil prices have already surged by approximately 30% since their June lows, approaching the USD100 per barrel mark. This increase is supported by a tightening demand and supply balance, which is expected to worsen in the fourth quarter.

SHORT ON GBPCAD AS CAD GAINS STRENGTH

I recommend initiating a short position on EUR/USD at the price of 1.074 top of a range bound formation, with a predefined take profit level of 1.058 and a stop loss set at 1.082, ensuring that the risk does not exceed 1% of total equity. Here's the rationale behind this recommendation:

1. Eurozone Stagflation Concerns: The Eurozone's increasing vulnerability to stagflation, characterized by stagnant growth and inflationary pressures, has cast a shadow on the euro's outlook. Historical data shows that such economic conditions have historically weighed on the euro's performance.

2. USD Strength: The US dollar has been exhibiting notable strength, and there is potential for this trend to persist, especially if US economic data continues to improve.

3. Overvaluation of EUR/USD: My short-term fair value model indicates that EUR/USD is currently overvalued. Given the ongoing concerns and dynamics in the market, a correction in favor of the US dollar is plausible.

4. ECB Policy Uncertainty: The market's skepticism regarding the European Central Bank's (ECB) future policy actions, with a relatively low probability assigned to a rate hike, adds further uncertainty to the euro's prospects.

5. Risk Management: To manage risk effectively, I recommend keeping the stop loss at 1.082, ensuring that potential losses do not exceed 1% of your total equity.

EUR/USD looks vulnerable therefore short on EURUSD

In the Conference Board survey, the comparison between the difficulty of finding jobs and the abundance of available jobs displayed a significant drop of two standard deviations month over month in the labor market during August. This drop aligns closely with the shortfall observed in the Non-Farm Payrolls (NFP). When I engage in modeling exercises like this, my primary focus is on addressing the NFP shortfall rather than the specific numerical value.

Furthermore, if we examine data dating back to 1998 and analyze the fluctuations in the Conference Board's job indexes in relation to the NFP deficits, the trend has persist since then.

This month, we find ourselves firmly situated within the first quintile. The consistent downward trend from the lowest to the highest quintile is a positive indicator that this outcome is not a random occurrence. It likely signifies that the job-related elements contain valuable insights that are not captured in economist surveys. This discrepancy arises because these components are made public just a few days prior to the release of the Non-Farm Payrolls (NFP) report, preventing them from being integrated into forecast models.

Turning our attention to the ISM employment, it's worth noting that these indexes should ideally be considered in economist forecasts, yet they often seem to be overlooked. Applying the same analytical approach to this data yields slightly less smooth results. This discrepancy can be attributed to the fact that we are comparing the changes in ISM job components from the previous month to the current month's NFP figures, utilizing data that is one month old. Nevertheless, it is evident that declines in ISM employment frequently foreshadow weaker NFP outcomes.

NFP Revisions: Another crucial factor to consider is the trend in Non-Farm Payrolls (NFP) revisions over the past six reporting periods, which has consistently shown downward adjustments. The momentum in revisions is closely correlated with actual employment trends. When the total 6-month revisions dip below -200 and when revisions remain negative for six consecutive months, NFP outperforms expectations only 42% of the time. In contrast, when analyzing data from 1998 to 2023, NFP exceeded expectations 48% of the time. While not a dramatic shift, this pattern offers another piece of the puzzle that may impact NFP outcomes.

Trading Strategy: In light of this probabilistic analysis, it appears to resemble a 60/40 bet with favorable risk-reward characteristics and a positive expected value (EV). A "normalization" or Goldilocks scenario in NFP figures should alleviate concerns about rising yields and potentially boost oversold currencies, such as the Australian Dollar (AUD).

A straightforward approach to capitalize on this assessment is to long AUD, priced at approximately 10 pips above the 0.6435 spot rate. I'm incorporating this into my current positions, despite already holding an AUD spot position. This decision is reinforced by the recent sustained strength in gold prices and my expectation that the significant triangle formation in copper will resolve to the upside.

LONG ON AUD

I recommend considering a short position on the AUD/CAD currency pair as my trade of the week. This recommendation is grounded in a comprehensive analysis of recent market trends and key economic indicators.

Rationale for the Trade:Over the past fortnight, I have observed a notable resurgence in AUD-crosses. However, my analysis suggests that the current market environment presents an opportune moment to initiate a short position. My  decision is informed by several factors:

Upcoming Chinese Data: I anticipate significant market movements as pivotal Chinese data is slated for release later in the week. Specifically, both manufacturing and non-manufacturing PMIs are scheduled to be published on Thursday morning. It's worth noting that recent Chinese economic data has consistently fallen short of expectations, particularly within the manufacturing sector, which has already entered a contractionary phase.

Australian Inflation Trends: My evaluation of domestic economic indicators indicates a potential further deceleration in monthly inflation rates in Australia throughout August. This could exert additional downward pressure on the Australian Dollar (AUD), contributing to the rationale for my short position stance.

USD Strength Anticipation: My analysis aligns with the likelihood of USD strength in the near term, with potential reinforcement from month-end flows. Consequently, this USD strength is expected to drive Canadian Dollar (CAD) outperformance against other G10 currencies.

Trade Details: The following trade parameters are suggested:

Position: Initiate a short position on the AUD/CAD at the current rate of 0.8782.

Target: Set the profit target at 0.8600, aiming to capitalize on the anticipated downward movement in the currency pair.

Stop Loss: Implement a stop loss at 0.8850 to mitigate potential losses and manage risk.

Risk Disclosure:It's imperative to acknowledge that all investments come with inherent risks. The foreign exchange market can be volatile, and past performance is not indicative of future results. The decision to enter a short position on the AUD/CAD should be made with a clear understanding of the risks involved. Market conditions can change rapidly, and unexpected events may impact the trade's outcome. It is recommended to thoroughly assess your risk tolerance and consult with financial professionals before executing any trade.

In conclusion, my recommendation for a short position on the AUD/CAD is underpinned by a holistic analysis of relevant economic data and market dynamics. As with any investment, the decision to act should be accompanied by a thoughtful consideration of the associated risks and the potential for financial loss.

AUD to weakness on CAD back

The Japanese Yen (JPY) has exhibited a sustained and prolonged weakness, a trend I've highlighted in my previous blogs on ACY.com.au. I now anticipate this downward pressure on the JPY to endure for an extended period beyond my initial projections. Several prevailing factors underpin this viewpoint.

Primarily, Goldman Sachs economists has recently outlined a more dovish trajectory for the Bank of Japan's (BoJ) policy approach from the present juncture. This projection entails a lengthier timeline for the cessation of the negative interest rate policy (NIRP), potentially manifesting around the spring of 2025. In contrast, current market sentiment aligns with an earlier termination, likely in the latter half of 2024. My rationale for this discrepancy lies in my assessment that the BoJ will likely necessitate the intervening period to ascertain the sustainable attainment of its targeted 2% inflation rate. Integral to this appraisal is the requirement for robust wage growth momentum.

Furthermore, my analysis indicates a likelihood of US interest rates persisting at elevated levels for a protracted period, a stance differing from consensus expectations. This assessment derives from Goldman Sachs economists' conviction that the probability of a resurgence in US economic momentum surpasses the potential of a recession. Consequently, my outlook envisions a stabilization of the US federal funds rate within the range of 3% to 3.25%.

The confluence of these factors contributes to the ongoing depreciation of the JPY. Notably, the BoJ's distant positioning from rate hikes and the continual buoyancy in equity markets work in tandem to perpetuate this weakening trend. Additionally, my forward-looking perspective on the Chinese Yuan (CNY) indicates an inclination towards depreciation, adding to the downward trajectory of the JPY.

In light of these considerations, I'm compelled to revise my projections for the USD/JPY exchange rate. Over the forthcoming 3-, 6-, and 12-month periods, I anticipate USD/JPY levels of 150, 155, and 150, respectively. My longer-term outlook, encompassing the conclusion of 2024, 2025, and 2026, posits USD/JPY rates at 135, 125, and 115. This forecast underscores the sustained weakening of the JPY.

It is imperative to acknowledge the inherent risks embedded in this forecast. Foremost among them is the potential for heightened inflation and consequential currency depreciation, which could elicit robust countermeasures such as currency intervention or a preemptive hawkish shift from the BoJ, or possibly both, leading to an altered trajectory for the JPY.

USDJPY Still Have Strength to push it Higher!

My view is that there is potential for further downside in the short-term for the EUR/USD, and I'm proposing a new trade idea to reflect this. I expect the pair to retreat towards the 200-day moving average support at approximately 1.0330. 

The recent decline in the EUR/USD can be mainly attributed to the USD strengthening, driven by robust US activity data and firmer inflation at the beginning of this year. As a result, market participants are becoming more optimistic about the Fed's policy outlook and are pricing in a more hawkish stance. The rise in US yields has been more significant than that of the euro-zone. The price action has also shown that the euro-zone rate market and EUR have already adjusted considerably to reflect the improving cyclical outlook at the beginning of this year. Although growth in the euro-zone was better than anticipated during the winter, the upside surprises in euro-zone activity data are beginning to diminish. The latest euro-zone PMI surveys for February will be monitored closely in the coming week to assess if business sentiment continues to improve. The euro-zone rate market anticipates a higher peak for the ECB, ranging from 3.50% to 3.75%. Nevertheless, the increasing euro-zone rates are having a lesser impact on boosting the EUR.

Short on EURUSD

Overnight NZ 2yr inflation expectations for Q1 saw a significant tick down to 3.3% from 3.62% in Q4, which has put the bird on the back foot vs AUD. This is an important development ahead of the RBNZ next week, who are doing the best to hike the economy and inflation expectations into submission. Clearly they won’t want to declare an early victory and risk unwinding their good work, but they will be very encouraged by this development. It gives me more confidence in my call that the RBNZ meeting next week will be a bit more dovish than expected, likely with a 50bp hike but opening the door to a much slower path ahead. I’m sticking with AUDNZD longs, looking for a close above 1.10 to make things more interesting. US CPI will dominate proceedings today. I think the risk is finely poised around the number but I’m hoping that the move up in yields recently has gone some way to at least pricing in the higher survey for the print. The market continues to want to trade GBP from the short side, for good reason as it looks like the BoE are coming to an end on their hiking cycle. But UK jobs data came in stronger than expected this morning, with more job gains than expected which saw the pound make brief gains vs EUR. The medium term bearish narrative shouldn’t be as important as positioning on the day and as such GBP could be a decent long on a low print if you expect to stop out some newly minted USD longs.

Maybe faster than expected

The hawkish tone of the 7 Feb RBA decision can bring new vigour to bullish AUD positions. With less than 25bp of hikes priced at Mar and Apr meetings, I see scope for monetary policy to be a more AUD-supportive factor. I hold my end-Q1 AUDUSD target unchanged at 0.7150 and trim my range from 0.6600-0.7300 to 0.6800-0.7300. 
I also hold on to my 1.1200 AUDNZD target and set a stop loss on the view at my entry level of 1.0770. While I still see the hypothesis of the RBNZ shifting less hawkish at its 22 Feb meeting as valid, the risks to the view have increased. The Q1 RBNZ inflation expectations survey on 14 Feb is a key source of risk.

This newfound RBA hawkishness also should in my view drive renewed interest in cross rate expressions where monetary policy divergences play a prominent role: AUDNZD is at the top of this list. I have held a bullish stance and a 1.1200 target for the pair since the beginning of the year, and while price action has been generally in line with my views, the real test for the position will be in 2 weeks, when the RBNZ holds its first interest rate decision of the year, on 22 Feb. OIS markets are pricing in now close to 50bp worth of hikes in Feb, down from closer to 75bp at the beginning of the year. Interestingly, the consensus of analysts polled by Bloomberg for the meeting is still firmly in favour of a 75bp hike. I suspect this might change as we near the meeting date.

AUD & NZD: Slowly but Surely

The strong US employment data very clearly helped to catch the market offside. Still, instead of pouring fuel on the retracement fire, Fed chair Powell doused it with extinguisher by looking through its impact somewhat. 

This could have a vol-suppressive impact as the market waits for US inflation data on 14 Feb. As far as my EURUSD view goes, these factors have played well for my view that taking profits at my previous 1.0950 target made sense. For the longer-term uptrend to stay intact, levels near 1.0720 need to hold on daily closes. This also happens to be roughly at the mid-point of the broader 1.0500 – 1.1100 range I can imagine holding for the remainder of Q1. Ideally, I would prefer to see a dip closer to 1.0600 before looking to buy again.

Ideally another dip before buying again!

It had been a relatively stable end to the week for the major foreign exchange rates until the BoJ Governor nomination was announced. It has resulted in USD/JPY falling  back towards the 130.00-level.

Governor nomination drags U/J back down to 130.00-level

In simpler terms, the value of the European currency (EUR) compared to the American currency (USD) started strong in February after meetings between the Federal Reserve and the European Central Bank. The market is uncertain about the Federal Reserve's plans to raise interest rates and is putting more trust in the European Central Bank's plans to keep rates low. This uncertainty has affected the value of the USD and made the EUR a more attractive investment. However, the Federal Reserve may change their plans in March and this may affect the value of the currencies. Some investors are avoiding long-term investments in European bonds, causing yields to remain at lower levels. This is due to differences in plans between the Federal Reserve and the European Central Bank

Most salient to the story has been the continuing softening in US price pressures – prompting Federal Reserve Chair Jerome Powell to declare ‘the disinflation process has started’. Our team looks for core US inflation to fall even more sharply in the second quarter. This can send EUR/USD 1.15.

Lower natural gas and China’s reopening have prompted global growth to be revised higher. That’s good news for the Euro. A hawkish European Central Bank can also see yield differentials lift EUR/USD.

The main risks stem from sticky US inflation, energy, and China. US debt ceiling negotiations may well prove a challenge in the third quarter too.

Luca Santos

Luca Santos

Sep 27 2023

LONG ON USDCAD

2

Luca Santos

Sep 21 2023

SHORT ON GBPCAD AS CAD GAINS STRENGTH

3

1

Luca Santos

Sep 07 2023

EUR/USD looks vulnerable therefore short on EURUSD

6

Luca Santos

Sep 05 2023

LONG ON AUD

4

Luca Santos

Aug 31 2023

AUD to weakness on CAD back

4

Luca Santos

Aug 29 2023

USDJPY Still Have Strength to push it Higher!

3

Luca Santos

Feb 21 2023

Short on EURUSD

3

Luca Santos

Feb 14 2023

Maybe faster than expected

3

Luca Santos

Feb 13 2023

AUD & NZD: Slowly but Surely

2

Luca Santos

Feb 13 2023

Ideally another dip before buying again!

2

Luca Santos

Feb 13 2023

Governor nomination drags U/J back down to 130.00-level

5

1

Luca Santos

Feb 10 2023

EUR/USD: A Change of Heart and of Forecast

6