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FX Update: Smaller central banks slowly tightening the screws. Meh.

Forex 6 minutes to read
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John Hardy

Head of FX Strategy

Summary:  First it was the Bank of Canada QE taper, now the RBA teases a likely July tightening move, while expectations for less accommodative Bank of England guidance this Thursday are heating up as well. What are FX traders to make of this development and what would it take to get the Fed on board this trend? Also, a look at the market reaction to the April US ISM Manufacturing survey yesterday.

FX Trading focus: CB’s are tightening – but not the Fed yet. Risk sentiment dominant.

The Bank of Canada was the first G10 central bank to execute an actual monetary policy tightening almost two weeks ago, as it tapered the pace of purchases, although follow on action in rate expectations has seen little change. Overnight, we got an RBA that is clearly putting the July RBA meeting in play as one that could bring a tightening move as well, as the statement upgraded the economic outlook, explicitly stated that the Bank would decide in July whether to roll forward the yield-curve-control (of capping yields on “3-year” Australian Government yields at 0.1%) from the April 2024 AGB to the November 2024 AGB, and “consider future bond purchases” as the $100 billion in QE is set to be complete in September and will require guidance on whether the RBA will continue to do QE.

The RBA statement failed to inspire any enthusiasm for the Aussie overnight, as we continue to see the AUDUSD pair embedded in the 0.7600-0.7800 range that has prevailed all year, save for a few probes of the lower end of that range and a one-week burst of enthusiasm that saw 0.8000 tested and rejected. Elsewhere among AUD pairs, some decent technical and thematic interest in AUDNZD lies just ahead this evening as the RBNZ is set to present its Financial Stability Report, just before the latest employment and wages data. The AUDNZD has been riding back and forth over the 200-day moving average (currently near 1.0750) over the last couple of weeks and is taking a stab at pulling away to the upside after the RBA statement overnight.

While the RBA has put its guidance on YCC and QE into play, the RBNZ is more focused on delivering a strong message on what it will do about soaring housing prices after the NZ government’s recent expansion of the RBNZ mandate to include house price considerations. On that note, more focus on housing is likely in the FSR rather than focus on monetary policy – which is less NZD positive – but let’s see. Reuters reports that RBNZ governor Orr is ill, by the way, which could play into how clearly the message from the FSR is delivered tonight in the testimony before a parliamentary committee.

As for the Fed, the market has taken the Fed at its word since last week’s FOMC saw the monetary policy statement and the Powell press conference stonewalling on providing any further guidance, and Fed rate expectations are closer to the lows of recent ranges than the high.

Bank of England preview
And then there is the Bank of England this Thursday and here the expectations are a bit more “developed” than elsewhere as the Short Sterling STIRs are unique relative to the other liquid STIR markets as they have pushed to new lows here, i.e., that the market is moving forward the date of the first expected rate hike from the BoE, currently priced near the middle of 2022. The estimated lift-off time frame is similar for the Bank of Canada (while the first Fed hike not priced until Q4 of ‘22) but again, the UK expectations are at the high of the cycle here two days ahead of the BoE meeting. One small likely tweak will be an extension of the time frame for completing its GBP 150 billion of QE to the end of the year from November – hardly dramatic stuff. But the BoE will have to strongly upgrade cautious February forecasts and its wording on the strength of the current strong rebound and how “transitory” any fresh inflation rise will prove could yet move the needle.

One thing that has likely held back sterling recently is the increasing headwind from the risk of another Scottish independence referendum in the wake of this Thursday’s Scottish election. With a Scottish exit from the Union, England and the remainder of the UK would be better off in terms of fiscal dynamics as Scotland has been a large net beneficiary via internal fiscal transfers within the union for years (Northern Ireland is by far the largest net receiver of fiscal transfers per capita). However, all of the uncertainty about the divvying up of debt and customs borders, etc., in the event a referendum effort begins to gain steam would likely play like some watered down version of the Brexit years. A Bloomberg article highlights the stark contrast in the Leave vote among Scottish youth.

What does it all mean?
What does it all of the above mean for currencies here? With the Fed not really in play here on the central bank tightening theme, the broader implications of various smaller central banks’ tightening tendencies noted above are somewhat limited, unless they extend further from here while risk sentiment remains on. For example, as economic performance differentials suggest that the rest of the world is playing catch-up with a white-hot US, with the latter’s heat likely set to fade quickly from May onwards as the “stimmy” effect fades, even as lockdowns end.

In the meantime, it was interesting to see the reaction to yesterday’s April US ISM Manufacturing survey, as the headline disappointed at 60.7 while Prices Paid rose even further to a blistering 89.6, the highest level save for a pair of readings in 2008 since the 1970’s. Interestingly, treasuries rallied on this number rather than selling off, presumably on the weaker than expected headline number, though given that March saw the highest number, at 63.7, since the early 1980’s, it is very difficult to sustain a reading anywhere near that level, given that these are comparative, “diffusion” indices. The April ISM Services number tomorrow is far more interesting, anway. But with the treasury back-up, the USD and the JPY rallied, showing that central bank guidance adjustments elsewhere may not carry much weight if risk sentiment wobbles here and volatility picks up again. The major US equity indices are rolling over in momentum terms.

The recent EURUSD rally has helped to neutralize the downside threat, although it isn’t helpful that the rally didn’t sustain the price action for longer above the 1.2100 area. The psychological 1.2000 level is in play here, and if risk sentiment continues to crumble for a time, EURUSD could be primed for a further setback below 1.2000, but we’ll remain on the look out for sell-offs to be gathered up, possibly at 1.1875 if the 1.2000 area can’t remain sticky here. Certainly, the growth comparisons are set to look less US-positive soon as Europe opens up over the summer from lockdowns and US cash drop stimulus fades.

Source: Saxo Group

Table: FX Board of G-10+CNH trend evolution and strength
Most interesting in recent developments are gold and even more so, silver picking up momentum, though spot gold needs to trade above $1,800/oz. probably to prove its case, while silver has sprung to new local highs. Elsewhere, CAD and NOK momentum are fading even as crude oil is doing all it can to support, and the USD downtrend is easing in strength, with more needed to turn the tide positive.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
In the individual breakouts, note the AUDNZD trend trying to turn positive ahead of a key couple of event risks in New Zealand tonight noted above. EURJPY is the oldest G5 trend at 26 days – interesting to watch that for a trend change if risk sentiment sours and yields dip again – the JPY looks too weak in general if yields remain rangebound, much less if bonds rally.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1230 – Canada Mar. Building Permits
  • 1230 – Canada Mar. International Merchandise Trade
  • 1230 – US Mar. Trade Balance
  • 1400 – US Mar. Factory Orders
  • 1700 – US Fed’s Daly (Voter) to Speak
  • 2100 – New Zealand RBNZ Financial Stability Report
  • 2245 – New Zealand Q1 Employment Change / Unemployment Rate
  • 2245 – New Zealand Q1 Average Hourly Earnings
  • 0110 – RBNZ members testify before a Parliamentary committee
  • 0130 – Australia Mar. Building Approvals

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