Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Chief Investment Strategist
Summary: Geopolitical risks are up on the radar again this week, and safety bids could continue. Dollar and gold continue to be supported by current macro framework along with conflict risks. CHF and JPY are also getting a safe-haven appeal, but JPY less so and CHF also faces lack of monetary policy support. AUD rally on any China data outperformance could be precarious, much like NZD’s today after election outcome.
Friday’s price action was a clear case of run to safety. Equities sold off while bonds, dollar, Swiss franc and Gold rallied. There were threats from Israel’s military about “significant ground operations” and a potential invasion of Gaza, which sent more than half a million Palestinians fleeing south. Meanwhile, comments from Iran that it will “not remain an observer” also fuelled further anxiety especially in the oil markets, given Iran’s significant ramp up in oil production and exports this year. This also garnered a huge bid in oil, with Brent up 5.7%.
The Asian session however saw some of these trends reversing marginally with US and its allies attempting to prevent further escalation in the Israel-Hamas conflict. Geopolitics will continue to be a key driver for markets in the week ahead as investors continue to weigh the risks of an escalation with the approach of the US authorities to prevent the conflict spreading to rest of the Middle East region.
Dollar and gold remain the safe havens of choice, given the boost to these from a variety of factors. Dollar, in addition to the geopolitical premium, also continues to enjoy US economic resilience and carry advantages. We have noted previously that dollar upside is starting to get limited, and carry advantage could also be eroded as it becomes expensive amid rising volatility and the decline in bond yields.
Meanwhile, Gold has added advantages from declining real yields with the safety bid in Treasuries driving nominal yields lower and inflation expectations remaining anchored, however a stronger dollar may lead to some compromise in Gold’s gains.
Other safe haven choices are CHF and JPY, but JPY has shown less of a safety bid in this situation due to the increased risks from the higher oil prices as an oil importer. Monetary policy is also not supportive of the CHF as inflation becomes less of a concern and recession risks take centre stage. The other way is to play the potential oil price upside, most evident in NOK and CAD, in addition to another bid in the USD. Meanwhile, EUR is at risk due to the potential of an energy shock.
Any upside in AUD continues to be precarious. Not only are the current geopolitical risks a reason to stay away from risk-sensitive currencies, but also the slowing growth environment but sustained inflation levels have continued to make the macro environment extremely complicated. But AUDUSD continues to find support at 0.63, even though upside is limited.
China’s activity and GDP data, out this week on Wednesday, could be key. If there is a beat on headline numbers, rhetoric on stimulus impacting activity will gain traction. There are also increased calls for stimulus again after China returned from holidays, and any measures could temporarily support the AUD. RBA meeting minutes due on Tuesday will unlikely be a game changer. AUDUSD could target 0.64, but USD strength and geopolitics will still likely remain the over-arching themes this week.
Weekend elections brought a victory for the opposition National Party and Christopher Luxon will be the new prime minister, ending six years of Labor Party rule. The new government faces a challenging economic outlook with the RBNZ forecasting a recession as it plans to keep interest rates high to curtail inflationary pressures. NZD popped higher on the reports, but focus will quickly turn back to geopolitics and the overarching USD strength. NZ also reports Q3 CPI tomorrow morning, and it is expected to pick up to 1.9% QoQ from 1.1% QoQ in second quarter but cool to 5.9% YoY from 6.0% YoY previously. A softer inflation print could prompt a further dial-back on RBNZ rate hike expectations, pressuring NZD.