FX Update: G10 trading themes for 2022
Head of FX Strategy
Summary: Today we present a variety of trading themes for the G10 currencies in the New Year, many of which are looking for a reversal of the trends that marked the latter part of 2021. The year 2022 looks likely to deliver more volatility than 2021 delivered as the market adjusts to a tightening Fed and as the Fed possibly adjusts to a market unable to make that adjustment gracefully, among many other themes and very stretched developments as we head into the New Year.
FX Trading focus: Some trading themes for the new year
Today I have put together some thoughts on longer term trading themes that may develop in the New Year, with an attempt at identifying trades that will not prove over-correlated and play on a variety of developments, as well, potentially as trades that may do well even under differing circumstances than some base case (which never proves correct in full anyway.) Food for thought here in the last days of 2021, and certainly the outlook can change quickly in the New Year as the situation on the ground develops.
For Q1: Short GBP vs. USD and CAD
For this trading theme: the idea is that the omicron variant concerns will continue to fade, helping the US and Canadian economies to continue full steam ahead early in the year and for the outlook for both the Fed and BoC to shift higher relative to the outlook for the Bank of England, which the market has set about as hawkish as possible, given that the UK economy will have been heavily impacted by the energy crisis this winter and is more limited on supply side constraints than are the US and Canadian economies. As well, a clearing of omicron uncertainty and clear rebound in international travel and more constructive outlook for crude oil could give the Canadian dollar an additional boost. Finally, if the more hawkish Fed ends up triggering a seize-up in financial markets, the US dollar will tend to outperform sterling as a safe-haven. The trade is limited to the first quarter because for the balance of 2022, we are looking for the US dollar to turn lower, whether because the US economy decelerates sharply, meaning that Fed expectations have peaked and the market will begin sniffing out the next easing, or because beyond a possible March FOMC meeting rate hike, the Fed will bark louder than it will actually bite relative to other central banks. Pain levels for this theme: GBPUSD above 1.3650 and/or GBPCAD above 1.7500
For H1: Short CNH vs. AUD and EUR, short CHFJPY and AUDJPY
The “weaker CNH” theme is a simple one that is down to China having signaled that it is against any further CNH appreciation after signaling such by increasing banks’ foreign reserves requirements on the very day earlier this month that the US dollar had dipped to a strong new low for the cycle versus the renminbi (yuan). As well, with China having signaled that it is ready to provide more support to a somewhat weak economy, some of the easing will likely find its way into the currency, given the divergence with other central banks, who are nearly all in some form of tightening stance in early 2022. Our view of a weaker US dollar for the balance of 2022 fits with a weaker CNH as well, as the yuan often trades with directional sympathy with the US dollar. We choose the EUR and the AUD as the former is rather cheap and sentiment in Europe is about as bad as possible, while Australia will likely continue to rebound very strongly after its severe covid lockdowns and RBA policy expectations could play significant catchup in the first half of the year. Pain levels for this theme: EURCNH below 7.7 and AUDCNH below 4.45.
The stronger JPY idea (short CHFJPY and short AUDJPY) is a rather contrasting one and is here for balance, on the risk that global yield curves continue to flatten and the risk that longer yields never achieve lift-off, whether because the global financial system can’t stand a slowdown in USD liquidity provision from a tighter Fed. The JPY looks under-priced already relative to long yields and the risk of a financial market mishap if something goes awry quickly with this tightening cycle. AUDJPY is a classic risk proxy (i.e., a hedge against something “going wrong” with global markets next year for any reason that triggers a deleveraging across risky assets), while CHFJPY is a stab at looking for mean reversion after the extreme divergence in the long term PPP or REER of the two currencies (strong CHF, record weak JPY), as the very dim view of Europe has helped the CHF higher, with hot inflation seeing the SNB easing off the intervention at times in late 2021. Pain levels for this trade: CHFJPY 130.00 and AUDJPY 87.00.
For balance of 2022: Short NZDNOK, Short EURSEK
Short NZDNOK: The latter half of 2021 saw a dramatic repricing of the policy outlook for the RBNZ as governor Orr was quick to abandon QE and signal rate hikes on the political embarrassment of housing affordability spiking due to near-zero policy rates at a time when the left-populist government was running on a platform of lower housing costs. That policy repricing, relative to the repricing of other global central banks, likely peaked in Q4 and NOK adds a bit of potential upside on what we see likely as a strong market for crude oil next year, together with a revival of EU sentiment, which is in the cellar heading into the New Year. Short EURSEK is on a similar theme, and most at risk if we see an ugly new bout of risk deleveraging, which is why put option spreads may be a better way to trade the theme for the full year rather than in spot for that particular trade. Pain levels for these trades: NZDNOK above 6.25 and EURSEK above 10.50.
Chart: NZDNOK weekly
Of the trades above, the NZDNOK looks perhaps the most extreme in terms of relative valuation, especially on a simple long-term chart of the spot exchange rate. A fair value spread of the two currencies looks rather less dramatic (see below) but still offers support for the idea that the pair is in the upper reaches of its longer term range. NOK will possibly see further upside if the sentiment in the Euro-zone and on the euro improves next year and crude oil remains bid on a fuller recovery in demand, and the relative hawkishness of the RBNZ may have already peaked in 2021.
Chart: NZDNOK REER spread
The chart below shows the real-effective, CPI adjusted exchange rate that is a better reflection of the “fundamental” relative levels of the exchange rate. It suggests far less dramatic over-valuation of NZDNOK but still shows the exchange rate at the high end of the long-term range.
Table: FX Board of G10 and CNH trend evolution and strength
Watching and waiting for what the calendar roll brings us in early 2022. Let’s recall that the USD bottomed out on the very first week of 2021.
Table: FX Board Trend Scoreboard for individual pairs.
Merely presented here for interest and for relative ATR levels.
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