Head of FX Strategy
Summary: The RBA’s dovish stripes on display as the new statement released overnight clearly suggests the central bank is looking for an excuse to pause its tightening regime at the next meeting. Many pockets in FX lack conviction as we await key incoming risk events, and Fed Chair Powell’s two days of semi-annual testimony starting today may not even loom particularly large, with the Friday Bank of Japan meeting and US jobs report and next Tuesday’s US CPI release the next three event risks of note.
Today's Saxo Market Call podcast
Today's Global Market Quick Take: Europe from the Saxo Strategy Team
FX Trading focus: RBA punishes the Aussie with its dovish hike. Remarkable spread of ECB vs. RBA expectations. Fed Chair Powell testimony may not offer much.
The RBA hiked 25 bps overnight as widely expected, taking the cash rate target to 3.6%. The market read the statement as dovish on a small change of phrase In the guidance on further tightening, with February’s “In assessing how much further interest rates need to increase”, changed in today’s statement to “In assessing when and how much further interest rates need to increase”. The insertion of “when” is a tip-off that the RBA is looking for excuses to pause its tightening regime at one or more meetings to assess developments. Australia’s 2-year yield dropped some 14 basis points as the RBA is priced to reach a terminal rate now only about 40 basis points higher, near 4.00%. While the RBA is concerned that services inflation remains too high, it is clearly very concerned as well on the risks to the economy from the lagged impact of prior tightening already in the bag, particularly for households with adjustable rate mortgages. Some 800,000 mortgages taken out during the pandemic are due for a reset this year, with massive upward adjustments for payments as the mortgages roll to a new rate that is more than twice as high as those during the pandemic. An article from news.com.au suggests that the average Australian mortgage is AUD 600k, equating to a rise of about AUD 16,500 in interest costs over 12 months at the new rate.
But is the RBA at risk of a policy mistake? Time will tell, but it is certainly notable that the central banks trying to come in for a pause, including the Bank of Canada, risk another embarrassing pivot if inflation proves more persistent than expected, as is our base case. Also notable is that the ECB and the RBA terminal rate expectations are nearing parity at 4.00%! Who would have thought this was possible in any of the prior cycles of the last 20 years?
As noted in this morning’s Saxo Market Call podcast, the ECB is priced to do more than 150 basis points of further tightening, the most additional tightening in the coming two quarters of any DM central bank. That is beginning to look a bit stretched in relative terms. Of course, we must also recall how late cycle the ECB has been in past cycles relative to other central banks. Remember the actions of one of the most out-of-touch central bankers of the modern era. Jean Claude Trichet, who hike two months before Lehman Brothers’ collapse and again in the midst of the EU sovereign debt crisis in 2011.
Chart: AUDUSD
New lows for AUDUSD here locally after the dovish RBA move, which pushes the focus lower to the next target, the 61.8% retracement of the rally from the lows, which comes in near 0.6550. Ironic to see one of the historically favoured commodity proxies struggling for air at a time when we are supposed to be celebrating a new rebound in Chinese growth, which has only shown up in fits and starts in metals markets. AUD is more in the grips of the RBA’s foot-dragging on tightening. RBA Governor Lowe will speak tonight and may try to pushback against the aggressive market takeaway if he wants to insist on two-way potential from here for the RBA’s next actions.
Fed Chair Powell is out testifying today and tomorrow before Senate and House Panels, respectively. Much of the time will be eaten up by painfully boring political posturing from the Congressional members on the panel, but Powell will no doubt try to sound as chipper and confident as possible, emphasizing the hope that inflation has rounded the corner, but that the Fed will remain vigilant. I don’t see him needing to send a strongly hawkish message to his audience – the US Congress. Looming larger for the US dollar are the US jobs report this Friday and especially the CPI report next Tuesday after the re-acceleration in the January data.
Bank of Japan drama is set to continue both through Friday’s swan song from Governor Kuroda and as incoming Kazuo Ueda finds his feet. The “big reset” of the JPY higher, in my view is only likely on a combination of yields easing elsewhere simultaneously with a tardy Bank of Japan extraction from yield-curve control and shifting out of NIRP for the policy rate. As long as yields are on an upward trajectory elsewhere, the JPY may only reset modestly firmer if YCC is ended or the cap significantly loosened, if we are to take Ueda at his cautious word. Still, ‘tis the season of volatility potential for the JPY, not only on the BoJ leadership handover, but also on the Japanese financial year drawing to a close.
Table: FX Board of G10 and CNH trend evolution and strength.
The strong euro edging out the US dollar as strongest currency here, not a huge surprise given the rise in ECB expectations, while risk sentiment has staged a rebound. The Aussie is the clear loser for now.
Table: FX Board Trend Scoreboard for individual pairs.
Most of the flip-flopping here is in the obscure crosses, but note EURUSD on the cusp of trying to turn higher if it closes above 1.0700. Also, EURSEK has flipped to the upside as well, even if it remains in the shadow of the dive from above 11.40.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
