FUNDAMENTAL OUTLOOK: BULLISH
Hawkish Fed policy remains a key driver for Dollar strength. With headline >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. However, as a result of increasing fears of a growth slowdown (as evidenced by recent econ data), STIR markets have repriced lower, and now expects a terminal rate of 3.3% (versus >4% before the June FOMC meeting). As STIRs reprice lower, we are expecting that to act as a possible short-term negative driver for the USD. Even though lower STIRs should be negative for the USD, as a lot of hikes have been baked in, the growth concerns sparked further risk off concerns this past week, which supported the USD. The USD is usually inversely correlated to the global economy and trade, appreciating when growth & slows and depreciates when growth & accelerates (reflation). Further expectations of a cyclical slowdown and continued tight expectations has seen investors shun risk assets and even bonds (usually considered a safe haven), and the USD has been a key benefactor of the rush to safety in recent weeks. Even though US bonds are considered safe havens, the current high has seen a strong stock-to-bond correlation and has caused big bond outflows. With bonds not fulfilling its usual save haven role the USD has been the haven of choice.
As aggressive Fed policy has been supporting the USD, any incoming data (this week’s ISM Services and NFP) that sparks further aggressive hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger reactions in the USD. As the cyclical outlook for the global economy is very bleak, and the USD is considered a safe haven, it means incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger USD reactions. Further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields like rising commodity prices, rising expectations and upside surprises in data could also trigger further USD reactions.
Apart from this past week, the USD has reacted cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data gets, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad ISM Services PMI or NFP data this week could trigger reactions in the USD. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is close prior highs which acted as local tops for the USD. Thus, stretched positioning could make the USD vulnerable to mean reversion in the short-term. With a lot already priced for the Fed, it won’t take much for the Fed to disappoint markets on the dovish side. Any FOMC comments that suggests more concern about the economy than could trigger reactions in the USD
The fundamental outlook for the USD remains as long as the Fed stays aggressive and cyclical concerns put pressure on risk assets. But we do want to be mindful that lots has been priced for the USD, and as growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed due to higher recession risks. The opposite side to that though is that further concerns about the economy sees more safe haven inflows into the Dollar. Positioning is stretched, so we would prefer much deeper pullbacks for new med-term USD longs and would look for short-term catalyst that offer shorter sentiment trades against the current strong bull trend.
FUNDAMENTAL OUTLOOK: WEAK BULLISH
The CHF has been supported in recent months as STIR markets have steadily priced in higher interest rates for Switzerland, as well the SNB’s reluctance to intervene in the currency markets. At their June meeting, the SNB took a very aggressive policy step by hiking rates with 50bsp and removing their previous classification that the CHF is ‘highly valued’. Unlike other central banks, the SNB has chosen to try and tackle before it runs rampant by hiking rates aggressively. Their hike in June was the first hike since 2007, and if the bank follows through with a hike in September it will mean Switzerland will have positive interest rates for the first time in 8 years. There is scope for further CHF upside in the months ahead with 4 supporting drivers. SNB’s hawkish tilt, the bank’s acceptance of a stronger CHF with less intervention, negative underlying risk sentiment driven by the global cyclical slowdown, rising . The SNB did note that they are willing to be active in the foreign exchange market to ensure appropriate monetary conditions which means too much CHF strength could get the wrong attention from the bank.
Any incoming data (especially coming up early on Monday) or SNB comments that causes markets to price in even more aggressive policy from the bank could trigger reactions in the CHF. As a risk sensitive currency, and catalyst that causes big bouts of risk off sentiment could trigger reactions in the CHF. The more aggressive markets think the ECB will be with incoming hikes, the more aggressive they will be for the SNB. Thus, data that trigger hawkish ECB expectations could also be supportive for the CHF.
The SNB has not been as active in trying to devalue the CHF through sight deposits as they have been in recent years. With the bank now on a hiking cycle, any drastic appreciation could spark some intervention and would be a catalyst. As a risk sensitive currency, and catalyst that causes big bouts of risk on sentiment could trigger reactions in the CHF. Further lower repricing of ECB hikes could trigger downside in the CHF, and the biggest dovish risk for the currency is a big surprise miss in CPI .
The SNB surprised with a 50bsp hike and signalled, that unlike other central banks, they will not get behind the curve. Apart from a hawkish , we also have the economy on a steady footing, as well as less risk of intervention as SNB’s Jordan said they no longer see the CHF as highly valued (there is of course risk that they could intervene if the CHF appreciates too much too fast). This means that the bias for the CHF has changed to and we’ll be looking for big dips in the CHF for buying opportunities.