FX Update: Trading the central bank normalization theme.

FX Trading focus: Trading the central bank normalization theme in G10 currencies

Yesterday’s extremely hot June US CPI print saw a fairly modest impact across markets relative to the magnitude of the surprise. Sure, the USD did pick up in places and Fed expectations were jolted a few basis points, but there was no broad shift out of recent trading ranges, suggesting that the market continues to buy into the Fed view (or partial Fed view, at least, as dissenters are increasingly vocal) that inflation will prove transitory. Our view is that, while sequential month-on-month inflation measures are likely to moderate in coming months as some one-off factors fade, inflation is by no means transitory. Regardless, the market has respected that the Fed has shifted direction, so for USD bears to get the upper hand, the view will have to be confirmed that the Fed will lag in removing accommodation relative to the underlying fundamentals of real interest rates, current account deficits, etc...

Overnight, the RBNZ surprised the market with its hawkish move as discussed in the trade view on AUDNZD below and I decided to dedicate today’s update to considering a few medium- to longer term trades that may play out from here if we continue to see a deepening in the move toward central bank normalization from here. Hopefully, the trades are somewhat uncorrelated, though it is unavoidable that the first three may share directional sympathy if, for example, we lurch into some deep correction in risk sentiment.

Bank of Canada expectations today: a further taper and encouraging words – has USDCAD topped out here?

Some trade ideas for the next couple of weeks to couple of months:

NOK too weak?
The Norges Bank is likely to prove the first G10 central bank to hike rates, having specifically forecast that it is set to hike rates in September at its June 17 meeting and forecasting a rate toward 1.50% by the end of 2024. The NOK has been in for a rough ride to the downside despite that hawkish upgrade, however, and that despite the surge in oil prices (normally very NOK supportive) as the market’s surprise at the FOMC meeting just the night before the Norges Bank on June 16 surprised markets and caught many USDNOK shorts off guard – with short covering in USDNOK a possible driver of the considerable downside in NOK. This NOK squeeze may be near completion as the focus could return to central banks normalizing rates and Norway leading the way.

Trade: Long NOK vs. a basket of EUR, SEK and USD (stops if NOK is weaker versus all three and EURNOK, for example, trades north of 10.50 and USDNOK trades north of 8.90 while NOKSEK falls below 0.9700).

Chief risk for this trade: a further squeeze on NOK longs on a chunky correction in crude oil prices or in risk sentiment if Fed Chair Powell spooks markets in testimony before Congress this week and this sees the USD rising further.

EURGBP downside potential?
Today’s strong UK inflation print has pulled BoE rate expectations back toward the highs for the cycle, while UK Prime Minister is expected to remove all Covid restrictions next week, which could further supercharge UK activity numbers and have the BoE pull forward its rate expectations more in line with the market’s expectation for a move early next year, it’s recent mimicking of the US Federal Reserve’s stance on inflation likely proving “transitory” notwithstanding. EURGBP is trading heavily today, and earlier this week, we have to remember that the ECB is preannouncing that it is warming up some reassurance that QE won’t quickly come to an end next year with new guidance updates at is meeting next week – a meeting very unlikely to prove hawkish. Further out, the chief focus will be on the August 5 BoE meeting.

Trade: Short EURGBP at 0.8515 with a stop above 0.8620 for a test of 0.8300 (trading target: 0.8325)

Chief risk for this trade: the ECB review next week comes out less EUR negative than expected or weak risk sentiment generally weakens conviction in the strength of the forward outlook for sterling bulls.

Chart: EURGBP weekly
EURGBP is pushing on the bottom of the range today after the UK print this morning, which has helped UK rate expectations back higher, a break of the 0.8500 area support could lead to a test of the major post-Brexit referendum support into 0.8300.