FUNDAMENTAL OUTLOOK: WEAK BULLISH
Despite a decent recovery from the start of the year, the AUD has struggled in the midst underlying negative risk sentiment and China’s continued struggles with Covid breakouts. China’s economy is always a key focus for the AUD. While all major economies are expected to slow in 2022, China is expected to recover (monetary and fiscal policy very stimulative). The expected recovery is a key input for our AUD bias. China’s recovery and planned infrastructure spending should support Australia’s terms of trade due to key commodity exports like Iron Ore, Coal and LNG . There was some news out this past week that China is looking to set up a centralized iron ore buyer to counter Australia’s dominance. Iron Ore has not taken this news well, along with global growth concerns, and will be an important one to watch as Iron Ore is Australia’s top export and 80% of it goes to China. The RBA finally woken up from their slumber and starting their hiking cycle fairly aggressively is also supportive for the AUD. The short-term problem to the current bias for the AUD is the continued covid dilemma facing China right now. As long as the covid situation stays bleak, and China continues to lock down parts of the country due to their draconian covid-zero policy, the AUD might struggle to take advantage of positive drivers and makes it more sensitive to underlying risk sentiment.
Positive Covid developments in China (easing restrictions, more fiscal or monetary stimulus, or letting go of the covidzero policy) could trigger reactions in the AUD. As a risk sensitive currency, catalysts that causes big bouts of risk on sentiment could trigger reactions in the AUD. With the RBA just getting started with their hiking cycle, there is scope for them to turn more aggressive, and any catalyst that triggers higher hike expectations (RBA speak, and wage data) could trigger a response from the AUD. Any catalyst that triggers further upside in Australia’s key commodity exports (China stimulus, lifting covid restrictions, new infrastructure projects in China, higher fears) should be supportive for the AUD.
Negative Covid developments in China (increasing restrictions or adding additional ones) could trigger reactions in the AUD. As a risk sensitive currency, catalysts that causes big bouts of risk off sentiment could trigger reactions in the AUD. Any catalyst that triggers downside in Australia’s key commodity exports (additional China restrictions, demand destruction fears, and additional news on recent centralized iron ore buyers) could be negative for the AUD. With the RBA just recently shifting policy and hitting the ground running on hikes, there is more room for them to get more aggressive, but of course any RBA speak or info in upcoming meetings that talks down aggressive hikes could still be a short-term negative for the AUD.
The bigger picture outlook for the AUD remains positive for now, but that is largely dependent on what happens to China. The short-term covid issues have pushed back but not removed recovery expectations, but until the covid fog clears and the Chinese economy shows recovery signs, the AUD might struggle to maintain upside short-term momentum.
FUNDAMENTAL OUTLOOK: NEUTRAL
The CAD has enjoyed far more upside in the past few weeks than we anticipated. We’ve been cautious on the currency given Canada’s dependency on the US (>70% of exports) where the clear signs of a faster than expected slowdown and possible recession should deteriorate the growth outlook for Canada. Apart from that, the risks to the Canadian housing market can negatively impact consumer spending as interest rates rise higher at aggressive speed. Potentially damaging the wealth effect created by the rapid rise in house prices since covid. However, despite the risks to the economy and the outlook, markets still price in a very favourable growth environment for Canada, also supported by a big push higher in terms of trade due to the rise in commodity prices. Furthermore, despite clear warning signals, the BoC has chosen to ignore the negatives and has stayed surprisingly optimistic and hawkish. We’ve missed most of the move higher in the CAD as our bias has kept us cautious, but the risks are still present and with the currency close to 9-year highs (at the index level) we are looking for opportunities to trade it lower on catalyst.
As an oil exporter, oil prices are important for CAD. Catalysts that sees further upside in Oil (deteriorating supply outlook, ease in demand fears) could trigger CAD reactions. The correlation has been hit and miss in recent weeks though. As a risk sensitive currency, and catalyst that causes big bouts of risk on sentiment could trigger reactions in the CAD. With more market participants noticing cracks in the housing markets, a less dramatic decline in house prices could ease some of those concerns and provide some upside. Even though a lot of tightening has been priced in for the BoC , a big enough upside surprises in CPI that triggers further hike expectations could provide some short-term support.
As an oil exporter, oil prices are important for CAD. Any catalyst that triggers meaningful downside in oil (deteriorating demand outlook, ease in supply shortage, less supply constraints) could be a negative catalyst for the CAD as well. As a risk sensitive currency, and catalyst that causes big bouts of risk off sentiment could trigger reactions in the CAD. Since a lot of policy tightening has been priced into STIR markets, any negative catalysts that triggers less hawkish BoC expectations (faster deceleration in growth or ) could trigger outsized downside for the CAD. In recent communication, Governor Macklem started to mention some hiccups in housing. Big downside surprises in house prices could trigger speculation of a less hawkish bank and trigger downside for the CAD.
The bigger picture outlook for the CAD remains neutral for now. Given the clear risks to the growth outlook due to the slowdown in the US, as well as rising risks to the consumer and the housing market, we remain cautious on the currency, even though it’s moved much higher than we anticipated. With a lot of good news priced in for the CAD and yields, our preferred way of trading the CAD is lower on short-term negative catalysts.