G10 Core Views for April

FX Trading Strategy

Core Views

Modestly weaker USD in Q2: market focus on US financial fragility and the potential for resulting Fed cuts reminds me of H1 2008, a period when the Fed was cutting rates even as other central banks resisted its direction. While such outcome might not prove sustainable, it has potential to play out in Q2 after Q1 price action stopped out USD shorts. Still, a key difference with H1 2008 is that global growth and commodity prices lack momentum, which should limit the extent to which USD weakens given its current carry premium.

Looking for EURUSD to push towards 1.1250: at the start of Q1 I wrote “a hawkish ECB framework, lower energy prices in Europe and a market fixation with US disinflation potential all leave room for EURUSD to push again towards 1.0950 near-term.” With that framework intact / strengthened post US bank failures in March and a stubborn ECB, I expect an extension now to 1.1250. The key view risk is that banking stress spills over into Europe or that political tensions exacerbate, though the 1.0500 level should be strong support.

JPY strength can persist towards USDJPY 125: I was wrong in early Jan setting this level as my end-Q1 target, as excessive positioning, a slothful BOJ and upside US / European inflation surprises delayed JPY appreciation. But any real hint that the BOJ could shift away from YCC would likely create another wave of interest in long JPY positioning, given now-greater concerns about global macro fragility. Even without that shift, arguably JPY assets are looking more attractive anyway to Japanese investors. If US debt ceiling fears gather pace into the end of Q2, USDJPY could extend lower beyond 125.

GBP saw relative stability in Q1: after a torrid 2022, staying largely confined to my expected EURGBP 0.87- 0.89 range. Relative ECB hawkishness should allow for an upward EURGBP drift, but I suspect the BoE will not be shy to hike rates still more if the data support that, and so GBPUSD can rise towards 1.2650 over the quarter. If I’m wrong and the BoE decides to see through high inflation and shift in a materially dovish direction for reasons such as financial risk, EURGBP would quickly move above 0.9000.

High-beta G10 FX to underperform further vs EUR and JPY: The lack of momentum in global commodities prices suggests that high-beta G10 FX will struggle to benefit from a softer USD. In H1 2008, they also were supported by hawkish central banks - this time, not so much. This leaves me looking for further AUD & CAD underperformance vs EUR and JPY. As for USD pairs, I hold on to my neutral 0.6600 AUDUSD target and look to fade rallies to the top of the range I envision for Q2, between 0.6200 and 0.7000. I target 1.3450 in USDCAD and aim to fade rallies to the top of the range at 1.3860, with 1.3225 as the bottom of the range. I expect AUDNZD to trade between 1.0600 and 1.0950 and favour buying dips over selling rallies.

My bullish EUR and JPY views should lead to USDCNH downside within 6.70-7.10 range: The risk of financial contagion in China is very low – this will make USDCNH stable relative to other cyclical currencies. However, the PBoC remains dovish, unlike the ECB and BOJ.

10 Key Questions for Q2

1. Will the sharp reductions in inflation in Q2 anticipated by central banks such as the Bank of England materialize, or instead will we see more evidence of persistence linked to factors such as tight labour markets?2. Are banking tensions already in the rear-view mirror? Or is another phase likely in Q2? And can they develop in a parallel fashion on both sides of the Atlantic, or can they become more pronounced and impactful in the US?3. Will signs of lagging effects from rate hikes already seen in key economies manifest beyond the banking sector? And how quickly will recently tighter financial conditions spill over into the wider economy?4. Can the US debt ceiling debate become so clearly toxic that risk aversion is brought forward to Q2?5. Is the strong inversion between Q2 ‘23 and Q2 ‘24 implied Fed rates justified? This is basically the same question I asked at the start of 2023, and what seemed to be a negative answer was quickly reversed by US bank woes.6. Will new BOJ governor Ueda end YCC abruptly, in a manner that disrupts vulnerable global asset markets?7. Is ECB chief Lagarde’s view that monetary policy designed for price stability can be fully segregated from financial stability issues realistic?8. Will FX volatility catch up with more impressive moves in global rates vol? If so, what is the necessary catalyst?9. Will the war in Ukraine rise in intensity, bringing about fresh risks of Russia testing Europe’s mettle? And what is the likely channel of transmission to markets now that Europe is less reliant on Russian energy exports?10. Is the prospect of a house price collapse in “expensive” G10 markets such as Sweden, Canada, and NZ real? And can it get bad enough to threaten local banking sectors and force aggressive rate cuts?

Q2 Event Risk Calendar

Date Event

2-Apr Finland parliamentary elections4-Apr RBA rate decision (followed by SOMP)4-Apr RBNZ rate decision (w/Monetary Policy Review)12-Apr BOC rate decision (w/Monetary Policy Report)26-Apr Riksbank rate decision (w/Monetary Policy Report)27-Apr BOJ rate decision (first with Governor Ueda)2-May RBA rate decision3-May FOMC rate decision4-May Shanghai Cooperation Organization summit4-May ECB rate decision4-May Norges Bank rate decision7-May Thailand parliamentary elections11-May BoE rate decision (w/Monetary Policy Report)14-May Turkey Presidential Elections16-May Council of Europe summit in Reykjavik19-May G7 summit in Hiroshima23-May RBNZ rate decision (w/Monetary Policy Statement)4-Jun OPEC ministerial meeting6-Jun RBA rate decision7-Jun BOC rate decision14-Jun FOMC rate decision (w/dot plot and SEP update)15-Jun ECB rate decision (w/ forecast update)16-Jun BOJ rate decision22-Jun BoE rate decision22-Jun Norges Bank rate decision (w/Monetary Policy Report)22-Jun SNB rate decision29-Jun Riksbank rate decision

Fed potentially side-tracked

▪ Despite persistent strength in the labour market and slower-than-expected progress on returning core inflation to target, the Fed has moderated its hawkish disposition in the wake of recent bank stress. Markets flipped from pushing the Fed toward a higher terminal rate of more than 5.6% in early March to repricing a quick pivot to cuts in the second half of the year amid renewed recession risks.

▪ Financial stability / bank stress concerns have likely tightened financial conditions more than the explicit rate tightening, though the extent of this is difficult to measure, leaving policymakers much more cautious. Depending on the gauge, the change in financial conditions may look quite benign given the extreme volatility seen in rates.

Financial stability vs price stability

▪ Central banks must reckon with financial stability risks, while still in the process of fulfilling their price stability mandates. In the US, deposit flight concerns have translated into multiple bank failures and swift action from the official sector.▪ Moves to shore up liquidity in smaller banks, say through offering higher deposit rates, could dramatically accelerate the expected slowdown in loan growth later this year. Note small banks’ share of commercial lending has increased 10% over the last decade. Such a slowdown would support recession fears and the priced flip to easing.▪ This transmission of this lending dynamic to the real economy will take time to materialize, leaving markets highly sensitive to incoming data.

Inflation stickiness still top of mind in Europe and UK▪ While inflation across much of G10 remains uncomfortably high, euro area inflation has displayed particularly little progress back to target. The ECB, which has yet to experience acute stress in its banking system, has thus remained aggressively hawkish – hiking 50bp in March even as its forward guidance suggested more data dependence.▪ The “catch-up” in ECB tightening and increase in yield levels vs the US will likely remain thematic against this backdrop, particularly as financial stability risks remain under the microscope in the latter.▪ A similar story is evident in the UK, where services inflation remains exceptionally strong. That said, this may translate to pricing out of cuts, as opposed to a much higher terminal rate, given the ground already covered by the BoE.

USD: Hanging on by a Fed▪ Consensus expected general USD weakness in Q1, a view that was hurt badly by ongoing high US inflation and the pricing in at one point of a terminal rate around 5.6%. I suspect this initial move cleared many USD shorts out of the market. Therefore, once banking / funding stresses became an issue in March, the USD did not see the type of surge that many would have expected.▪ The question again becomes whether the scale of rate cuts priced in for H2 ‘23 can be realised or not. I suspect in Q2 the market will keep pricing cuts in simply because high inflation can be characterized as backward-looking while any surprise falls will be seen as vindicating current pricing.

EUR: Still being carried by the ECB

▪ The move lower in global rates seen in the second half of March did not leave expectations for the ECB untouched. But the ECB’s 50bp rate hike last month pointed to a strong commitment to stay the course on rate hikes, considering ongoing high inflation. The central bank also seems confident the euro area banking system does not face risks as seen in the US or Switzerland.▪ The ECB sticking to its guns would leave EURUSD open to a push towards 1.1250 in my own view. The fact that EUR quickly bounced back from a phase of being pressured due to banking stress points to underlying structural demand, including the fact that higher rates provide a reason for persistent portfolio outflows to stop / reverse.

EUR: ECB aversion to inflation is key▪ Cheered on by more hawkish elements from countries like Germany and Austria, the ECB continues to send a clear message that it is prepared to prioritise fighting inflation over theoretical concerns about financial stability or even future disinflation risks stemming from tighter financial conditions. Anything less than a sudden drop in inflation in Q2 will keep this bias in play.▪ Partly as a function of this relentless ECB focus on prices, FX market participants have not felt inclined to price in a major risk premium. Still, risk reversal skews still point to fears of downside and, as a result, the possibility of upward spot drift if problems don’t materialize. EUR has remained impressively immune to issues such as French pension-related conflict or the possibility of sovereign spread issues in the periphery.

JPY: BOJ still playing chicken with markets▪ New BOJ governor Ueda takes the helm on 8 Apr and will chair his first meeting as chief on 27-28 Apr. Ueda takes over with “core core CPI” at 3.5% y/y in Feb, a four-decade high. And on 17 Mar, the Rengo trade union confederation struck a deal with major employers to raise pay by a larger-than-expected 3.8% on average. These events bode well for monetary tightening measures such as an end to YCC.▪ At the same time, it’s not clear small companies that are less unionized and employ the bulk of the population can deliver 3% plus pay hikes. Meanwhile, worries about regional banks in the US have also shone light again on Japan’s own fragile regional bank sector. With bond yields having slumped too with the 10y yield well below the 0.50% upper YCC limit, it’s unlikely Ueda sees urgency to act.

JPY: Changing times for Japanese investors▪ Inverted yield curves have materially diminished the attraction of overseas debt for Japanese investors on a hedged basis. Although in theory this should have no FX impact, it points to possibilities for more general domestic bias were rates to meaningfully converge between Japan and especially US markets after so many years of persistent net outflows from Japanese institutions since QQE began in 2013.▪ Recent data show sharp declines in Japanese long-term portfolio assets, likely reflecting a mix of actual net selling and also price changes in an environment of large losses. The bottom line is that the magnet for capital to flow overseas may have lost much of its strength, especially given still-negative real rates in major economies.

GBP: More stable times for now▪ GBP in Q1 was helped by excess short positioning due to a strong consensus that BoE dovishness makes it a compelling short. While the central bank did actively push back against this characterization, it nonetheless hiked its base rate twice and is still priced to reach at least a 4.50% terminal rate this quarter.▪ As in other major economies, the bigger question is how quickly the BoE is able or willing to start cutting rates again once that level is reached. Much will depend on whether UK inflation starts a sharp fall by endQ2 as the BoE expects. If not, it is hard to imagine such cuts materializing shy of a major financial sector meltdown. This creates two-way directional GBP risk, as cutting while inflation is still high would hurt the currency, while holding firm on higher rates if inflation persists can create upside risks.

GBP: Can inflation fall quickly given wages?

▪ UK inflation remains top of the pack among major economies and still delivering upside surprises, with service prices driving recent gains. While there are many reasons for this, labour market tightness and sharp wage growth are a key element. Falling participation rates are a big driver, with BoE chief Bailey directly pointing to high rates of early retirement.▪ Whatever the reason, the risk is that public sector wage growth continues to push higher in an environment of widespread strikes and labour disputes, which raise the odds of inflation expectations becoming entrenched. The BoE needs to believe strongly that financial conditions tightening is a major barrier to this process if it is to stop hiking rates. Simply doing so without that evidence would be a danger for GBP.

CHF: SNB keeps its hawkish bias

▪ Targeting 0.9600 in EURCHF for the end of Q2 and fading moves above 1.0200.

▪ SNB hiked rates again by another 50bps in Mar to 1.50% and wouldn’t rule out further tightening despite the turmoil in global financial markets.

▪ The central bank is concerned about inflationary pressures from abroad and second-round effects, given the tightness in the labour market. A stronger franc helps the SNB to achieve its inflation goal.

▪ The risk is a continuation of the current global disinflationary trend leading to a lower SNB long-term inflation forecast. Also, an overly strong franc can lead to SNB FX purchases.

CHF: SNB keeps its hawkish bias

▪ The unemployment rate stood at 1.9% in February, a twenty-year low.

 ▪ So far, actual wages have lagged inflation, but with the labour market still strong, higher wages going forward cannot be ruled out.

▪ However, there are some tentative signs that growth and employment prospects are deteriorating.

▪ A sharp slowdown in the global growth outlook would alleviate domestic inflation pressures and could lead to a more dovish SNB as a result.

AUD: Weakened by dovish RBA and mixed backdrop

▪ The improvement in Chinese activity that I anticipated in Q1, as part of my bullish AUD view, failed to materialize. While a belated rebound is possible, the bar for impact on AUD is higher, as terms of trade have fallen sharply in the meanwhile. This reduces the odds of a growth- / reflation-driven AUD rebound in Q2.

▪ Markets are now pricing in no further hikes from the RBA, and ~25bp worth of cuts by year-end. RBA tightening expectations have corrected much more aggressively than for the Fed in Q1.

▪ In the near-term, especially ahead of the RBA review expected around the 9 May budget, I do not anticipate major changes in the policy outlook. AUD should continue to underperform FX with hawkish CBs.

AUD: Econ data could still challenge the RBA’s resolve

▪ Looking ahead, the RBA policy outlook however might change. The dovish shift in policy tightening expectations could turn out to be excessive in scope if economic data were to prove resilient.

▪ So far activity and inflation data are quite mixed. Inflation expectations remain elevated, job vacancies still point to a tight labour market, steady rent growth highlights upside inflation risks.

▪ The bigger question is whether the RBA would respond to stronger data surprises, if they were to materialize. The risk of BoE-style disappointment is likely to persist.

NZD: No distinctive story in play for most of Q1

▪ NZD was directionless in Q1. The view that the RBNZ would not live up to the aggressive pace of rate hikes that markets were pricing in was correct but was overwhelmed by the much more volatile outlook for RBA monetary policy.

▪ I don’t see high odds of this changing in Q2. The data are showing signs of weakness (e.g., Q4 GDP), but other demand indicators are still holding up, as per the ongoing resilience in imports.

▪ The large deterioration in the trade balance has attracted the attention of rating agencies, but so far not of markets. A rating downgrade around the budget (in May) might make markets more alert to it.

NZD: Still vulnerable to a weaker turn in the data

▪ In Q1 we saw the resumption in net immigration trends as a reason to be bearish NZD, as I anticipated wage growth and labour shortages to ease. My view turned out to be premature.

▪ I think this aspect will remain nevertheless in play, as net migration is now back to pre-Covid levels. A looser labour market would increase the odds of the RBNZ turning less hawkish in Q2.

▪ As things stand, the RBNZ is still priced as the most hawkish CB in G10. This asymmetry still leaves us marginally net bearish NZD: still, I would need to see softer data before acting on this view.

CAD: Exposed to US demand and local housing woes

▪ With the US now the leading petro-economy in North America, CAD has scope to react more to domestic drivers and to US demand developments, and less to global growth momentum.

▪ In the near-term, I think this leaves CAD likely under pressure. Slowing US activity data is likely to feed into Canadian growth momentum. Housing remains an ongoing weight on local demand.

▪ The different structure of the housing market vs the US argues that any hawkish repricing in Fed policy expectations might not be closely followed by BoC policy expectations.

CAD: Still a uniquely constructive immigration story

▪ Immigration nevertheless remains CAD’s saving grace. Ongoing population growth is likely to keep aggregate demand supported (possibly for housing too), while at the same time undermining the risk of a price-wage spiral forcing the BoC into more rate hikes.

▪ For this reason, I’m inclined to think that the poor housing market data only tell part of the story for CAD. And are also somewhat sceptical of the very weak consensus around Q2 GDP data.

▪ All in all, this leaves me neutral CAD vs the USD. Against currencies backed by hawkish central banks, I think CAD has still scope to underperform.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.