Week Ahead: Key Themes & Trades

EUR: can the rally continue?

The EUR together with the GBP, CHF and, to a lesser degree, the SEK have emerged as some of the best G10 FX performers so far in 2023. This was the result of a number of factors: (1) ‘stickier’ inflation in the Eurozone; (2) a recovering Eurozone economy on the back of subsiding energy prices and relatively more stable banking sectors; and (3) an increasingly credible commitment by the ECB to tackle Europe’s inflation problem. In addition, the EUR has benefitted from the rotation out of the USD that started in Q422. More recently, investors have also been rotating out of the JPY, AUD, NZD and CAD as they reassessed their bullish outlook on China and given the relatively more dovish stance of the BoJ, RBA, RBNZ and BoC. While the rotation can continue especially if the policy rate differentials move further in favour of the EUR, my FX positioning data and FX valuation analysis suggest that many positives are already in its price.

I also note that the fundamental case for further EUR outperformance could weaken in coming months for several reasons: (1) European energy prices could be close to bottoming out as the EU in particular is forced to start replenishing its gas storage in coming weeks at a time when geopolitical risks stemming from the conflict in Ukraine linger; (2) recent lending data suggests that the ECB tightening has led to tighter credit conditions that could hurt the European economic outlook; and (3) the rates markets are expecting the ECB to keep tightening even after the Fed has embarked on rate cuts in H223 – pointing at excessive policy divergence in our view. Looking at the week ahead, focus will be on the European PMIs for April that together with the latest corporate earnings will allow investors to assess the impact of the recent banking sector turmoil on the global economy. Any negative data surprises could test the latest rally in risk especially given that sticky inflation will force the Fed and the ECB to remain very hawkish.

USD: the rotation continues.

The USD remains at the receiving end of the continuing rotation out of US assets as (foreign) investors are looking for better returns elsewhere. Indeed, our flow tracker for US stock-market ETFs has signalled that the outflows have intensified more recently despite the fact that US stock markets were able to recover from the March lows triggered by the banking sector turmoil. In that, it seems that the European stock-market ETFs remain the main beneficiaries of (unhedged) inflows. The key drivers of the continuing rotation seem to be the US stock valuations relative to their Eurozone and Japanese peers (using P/E ratios) and, more recently, the growing concern that the US is slipping into a recession while the Fed could remain laser focused on fighting inflation. Moreover, while the USD remains the unrivalled high-yielding safe-haven currency its appeal has been dented by (all-too) aggressive market Fed rate cut expectations. In contrast, the EUR’s and CHF’s growing rate advantage courtesy of the hawkish ECB and SNB have made them more appealing safe-haven currency. Looking ahead, there seems to be little on the calendar that could halt the rotation out of the USD in its tracks. That said, potential upside surprises from the US data and/or persistently hawkish Fed speak could slow down the pace of rotation out of the USD.

 CHF: emerging at the top

The CHF’s winning streak has shown no signs of faltering into Q223, as the CHF has kept outperforming its G10 FX peers thus far this month to become the top YTD performer. This has been especially visible in USD/CHF which has just broken below 0.90 for the first time in nearly two years. The tentative recovery in global risk appetite has by no means weighed on the CHF, nor have the latest Swiss releases. Headline CPI cooled by a greater extent than expected in March, with core inflation following suit with a surprising pullback too. Nevertheless, both metrics remain above the SNB’s inflation target, with the latter still trending higher overall. This should thus keep the bank’s tightening prospects intact, as we recall that the SNB remains one of the most hawkish G10 central banks left out there. Meanwhile, the decline in FX reserves in March suggested that the SNB likely sold some FX last month, albeit in no larger amounts than previously. Looking ahead, the domestic agenda appears very light for the week to come, while the interventions of SNB’s Andrea Maechler and Martin Schlegel are unlikely to bring any fresh food for thought on Wednesday. Ultimately, I retain a positive view on the CHF which could benefit from both its safe-haven nature if risk aversion hits back, and more appealing domestic credentials too, even though the latest spot rally has rather been met by more subdued demand for CHF upside in the option space.

JPY: keeping it dovish.

In his first full week as BoJ Governor, Kazuo Ueda has sounded doggedly dovish. Ueda linked any adjustment in YCC closely to the underlying trend in inflation, going against investor speculation that YCC could be adjusted to address its market side-effects. Ueda did say he is open to a policy review from a longer-term standpoint. Ueda also said the focus for monetary policy for now should be the risk that inflation could slip back below target. Nationwide CPI data for March is likely to show inflation in headline and core terms remained above 3% and well above the BoJ’s 2% target. Indeed, Tokyo CPI data implies stabilisation in nationwide headline and ex-fresh food inflation around 3%, but further acceleration in inflation excluding energy and fresh food above target. The latter would place some pressure on the BoJ’s view that inflation is going to drop below target in the coming financial year. For now, however, the JPY will remain weighed down by the dovish rhetoric of BoJ Governor Ueda. Support for the currency is coming from the market continuing to price in the peak in the Fed Funds rate in the coming month(s). Investor reluctance to load back up on risk given the threats of sticky inflation as well as further turbulence in the US banking system are also supporting the JPY as it has reattached to risk.

GBP: the unlikely outperformer. Together with the CHF, the GBP has emerged as the best performing G10 currency so far in 2023. The more recent GBP outperformance has reflected the growing divergence emerging between the market expectations for the Fed and the BoE that could be partly attributed to the persistence of the UK inflation overshoot when compared to the US. In addition, the recent US banking sector turmoil has increased the risks of further aggressive credit tightening and thus a recession in the US. In contrast, the more recent data releases have suggested that the UK may be able to avoid a recession and this is seen by investors as helping the MPC to focus its attention on the task of getting inflation under control. All that being said, we think that there is less scope for further divergence between the BoE and the Fed given that: (1) even if the Fed tightening cycle peaks in May, we doubt that this will be followed by aggressive rate cuts as expected by the markets at present; (2) despite the fact that the UK economic outlook is now looking less dire, the MPC should remain divided on the need for further aggressive rate hikes in our view; and (3) while we have seen the BoE hiking rates while the Fed was easing in the past, as currently expected by the markets, these occurrences have been quite rate in the last 30 or so years. We therefore think that, similar to the Fed, the BoE tightening cycle is very close to peaking. Looking ahead into next week, in the UK, focus will be on inflation, labour market and retail sales data for March. The GBP sentiment has improved of late but with many positives in its price it would take more upbeat data to give the GBP a sustained boost in our view.

CAD: on hold… but soon to fold?

USD/CAD’s range trading pattern continues to hold within 1.3250-1.3850, although the pair is threatening to break below its 200DMA (1.34) for the first time since last August’s failed attempt. Resilient risk appetite coupled with a rebound in oil prices since the OPEC+ decision to reduce output have underpinned the CAD which has been completely unmoved by the latest BoC decision to keep rates on hold for a second consecutive meeting in April. The bank removed its explicit guidance to a conditional pause, while still stressing that it stands ready to raise rates further if needed. That would possibly be if services inflation, inflation expectations and wages growth fail to cool convincingly. Yet, with regards to the last two points, the bank instead noted some progress in the right direction in the latest BoC Business Outlook survey and Canadian jobs report. This could be complemented by a similar move in the actual CPI data due out on Tuesday. In any case, it would require a sizeable upside surprise to eventually raise the prospects of a return of rate hikes, as Canadian money markets expect nothing other than unchanged rates at the BoC upcoming meetings. Ultimately, USD/CAD should keep a closer eye on rates/inflation considerations south of the border where the Fed’s near-term outlook embeds more uncertainties. On that front, it has to be noted that USD/CAD is yet to price in the tightest 2Y swap spread in more than six months, even though such a factor has lost some of its driving power in recent months. All in all, resilient risk appetite and energy prices could be more potent catalysts spurring some covering in the still very crowded short CAD positions.

AUD & NZD: more needed.

The approaching end of the FOMC’s tightening cycle will not necessarily be a positive for the Antipodean currencies. Historically, the conclusion of Fed tightening cycles has been accompanied by recession and weaker global growth, which weigh on the AUD and NZD. For this time to be different, two things would have to occur: (1) the RBA and RBNZ would have to keep hiking rates when the Fed has stopped; and (2) China would have to step up to boost global growth. We think the RBA and RBNZ both have one more 25bp rate in them. Based on current rates market pricing, such an outcome would be more positive for the AUD than the NZD. Australian labour market data for March leaves the RBA’s tightening bias firmly in place, but not just yet reaching for the rate hike lever given rising labour supply leading to the highest underemployment rate in a year, which will be a drag on wages growth. The Australian CPI report for Q1 (due the week after next) will ultimately determine if the RBA hikes rates again in May. The RBA Minutes to the April Board meeting, the first time the RBA was on hold after 10 hikes, will give a clue as to how close the decision was and if the RBA is willing to re-start rate hikes in May. NZ’s CPI data in the coming week will see a spike due to the supply-side shock of flooding following a cyclone hitting NZ’s North Island. Indeed, the RBNZ looks for 1.8% QoQ CPI inflation and a reacceleration in YoY inflation to 7.3%. While lower fuel prices will be a drag on inflation, food prices will keep pushing inflation higher. The RBNZ will have to look through the temporary shock to inflation and balance the longterm increase in demand due to the rebuild against the already slowing economy. The supply-side shock to NZ inflation means that it will be much less informative than usual for Australia’s inflation data release the week after. China economist expects its growth rebound to show through in the Q1 GDP data and retail sales and IP data next week. But this growth rebound will continue to be modest relative to previous ones.

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