Outlook of the Week: Macro Overview

Two steps back

Yesterday, some important information about prices in the US was released. This caused a lot of excitement in the financial markets, especially in the currency and interest rate markets. Even though the prices went up as expected, it was still seen as a negative event for the market's expectations, and there were some worrying signs about inflation in the economy.

As a result, some economists think that the Federal Reserve will have to raise interest rates in the near future to keep inflation under control.

This has caused some changes in the market's predictions for interest rates, and for how much the US dollar is worth compared to other currencies. While the US dollar has gotten a little stronger recently, it's not really doing that well considering all these changes in the interest rates.

There are 3 points that I would like to bring the attention for on this research;

1- Constructive risky asset environment: the S&P 500 is hovering around 5 -month highs despite US rates re -pricing, while credit spreads are also at comfortable levels. With the VIX sub -20 too, the traditional “risk off” reasons for extended USD rallies are not present. And even though “balloon incidents” are taking the sheen off Chinese assets (and by extension related markets like Korea), the tension levels are not so high as to unhinge ongoing China rebound hopes, now zero covid is over.

2- Muted relative rates divergence: although the USD has the highest yield support in G10, data flow in key competitors has told a hawkish story. ECB officials continue to talk in terms of further rate rises and going beyond market expectations potentially, while the BoC now must wrestle with Canada also positing strong jobs figures for Jan. In Australia, the RBA is facing upside inflation surprises, as are the Scandie central banks. Wage growth in the UK is rampant as we discuss below, while hopes are still high that the end of current BOJ chief Kuroda’s tenure will bring about the end of YCC and a stronger JPY by extension. In short, the USD just isn’t special enough anymore.

3- Terms of trade: as we’ve discussed in the recent past, low global gas prices are leading to terms of trade shifts that are favourable to European currencies and JPY.

For me, this leads to continue along the path I’ve been on this year, which in effect is;

A) Range trading EURUSD, where I’m looking for a move towards 1.0600 before hoping to the upside again as per my original view this quarter.

B) Looking for USDJPY to move only slowly towards 125.00 in coming months, rather than collapsing through that level quickly. On this front, I note that Japan economist expects the BOJ under likely new Governor Ueda will announce in April a review of the current monetary framework and in June abandon elements such as YCC while hiking the IOER to 0.15%. Still, with the 10 -year JGB yield again pushing against the 0.50% upper band, the pressure to take fresh action such as another band widening well before June will likely stay alive. Ueda’s Lower House hearing on 24 Feb will be carefully scrutinized for policy shift clues.

C) Selecting specific currencies like AUD that have some grounds for outperformance but pairing them against the likes of CNH rather than USD directly.

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