NZD USD - FUNDAMENTAL DRIVERS
NZD
FUNDAMENTAL OUTLOOK: WEAK BULLISH
BASELINE
What a head scratcher! The outlook for the NZD has been supportive for the currency on so many fronts. The RBNZ was the first major central bank to really ramp up aggressive policy expectations by setting out a clear hawkish path for higher interest rates and have recently hiked in 50bsp increments and also upgraded their terminal rate projections. Furthermore, the economy has been performing well and the growth outlook remains on a solid footing with no major hiccups expected compared to growth outlook in other major economies like the US, UK and the EU. The country also managed to sign an amended trade agreement with their biggest trade partner China, who has promised to open up more markets for NZ goods. However, despite all the positives in play, the NZD has been mostly rangebound for the past 19 months. There have been very big swings higher and big swings lower, but the currency (at the index level) has not been able to catch any sustainable bullish momentum despite it’s positive outlook. That does make us cautious with the currency, despite many things pointing to upside.
POSSIBLE BULLISH SURPRISES
Both CFTC and tactical positioning looks very stretched at the moment. With positioning at these stretched levels, some position squaring and mean reversion could trigger some upside in the NZD. As a risk sensitive currency, and catalyst that causes big bouts of risk on sentiment could trigger bullish reactions in the NZD. Positive Covid developments in China (easing restrictions, more fiscal or monetary stimulus, or letting go of the covidzero policy) could trigger bullish reactions in the NZD.
POSSIBLE BEARISH SURPRISES
Negative Covid developments in China (increasing restrictions or adding additional ones) could trigger bearish reactions in the NZD. As a risk sensitive currency, and catalyst that causes big bouts of risk off sentiment could trigger bearish reactions in the NZD. Since a lot of policy tightening has been priced into STIR markets, any negative catalysts that triggers less hawkish RBNZ expectations (faster deceleration in growth or inflation) could trigger downside for the NZD.
BIGGER PICTURE
The bigger picture outlook for the NZD remains positive for now, but that is largely dependent on what happens to China as the New Zealand economy is also very dependent on trade with China and Australia. However, we don’t want to ignore the clear rangebound price action exhibited by the currency over the past 19 months. For now, given the positive outlook and stretched short positioning, we would favour short-term upside catalysts over trying to chase the currency lower in the short-term.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
Hawkish Fed policy remains a key driver for Dollar strength. With headline inflation >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. STIR markets suggests aggressive policy action pricing a terminal rate of >3.8% by 2Q23 which should be a positive input for the US Dollar . Safe haven flows have also supported the USD as it’s usually inversely correlated to the global economy and global trade, appreciating when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown, accompanied by multi-decade high inflation and synchronized removal of monetary policy stimulus from major economies 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 as economic prospects have deteriorated. Even though US bonds are considered safe havens, the current high inflation 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 benefited from the rush to safety.
POSSIBLE BULLISH SURPRISES
As aggressive Fed policy has been supporting the USD, any incoming data (especially inflation ) that sparks further hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger bullish 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 any incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger bullish 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 and inflation expectations could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
More recently the USD has reacted more cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data slows, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad growth data could trigger bearish reactions in the USD despite its safe haven appeal. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is still close prior highs which acted aslocal 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. Thus, any FOMC comments that suggests more concern about the economy than inflation could trigger bearish reactions in the USD
BIGGER PICTURE
The fundamental outlook for the USD remains bullish 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 growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed as a result of higher risks of recession. Furthermore, given tactical and CFTC positioning, we would prefer deeper pullbacks for new med-term USD longs, but shortterm catalyst can still offer shorter bearish sentiment trades against the current strong bull trend.
FUNDAMENTAL OUTLOOK: WEAK BULLISH
BASELINE
What a head scratcher! The outlook for the NZD has been supportive for the currency on so many fronts. The RBNZ was the first major central bank to really ramp up aggressive policy expectations by setting out a clear hawkish path for higher interest rates and have recently hiked in 50bsp increments and also upgraded their terminal rate projections. Furthermore, the economy has been performing well and the growth outlook remains on a solid footing with no major hiccups expected compared to growth outlook in other major economies like the US, UK and the EU. The country also managed to sign an amended trade agreement with their biggest trade partner China, who has promised to open up more markets for NZ goods. However, despite all the positives in play, the NZD has been mostly rangebound for the past 19 months. There have been very big swings higher and big swings lower, but the currency (at the index level) has not been able to catch any sustainable bullish momentum despite it’s positive outlook. That does make us cautious with the currency, despite many things pointing to upside.
POSSIBLE BULLISH SURPRISES
Both CFTC and tactical positioning looks very stretched at the moment. With positioning at these stretched levels, some position squaring and mean reversion could trigger some upside in the NZD. As a risk sensitive currency, and catalyst that causes big bouts of risk on sentiment could trigger bullish reactions in the NZD. Positive Covid developments in China (easing restrictions, more fiscal or monetary stimulus, or letting go of the covidzero policy) could trigger bullish reactions in the NZD.
POSSIBLE BEARISH SURPRISES
Negative Covid developments in China (increasing restrictions or adding additional ones) could trigger bearish reactions in the NZD. As a risk sensitive currency, and catalyst that causes big bouts of risk off sentiment could trigger bearish reactions in the NZD. Since a lot of policy tightening has been priced into STIR markets, any negative catalysts that triggers less hawkish RBNZ expectations (faster deceleration in growth or inflation) could trigger downside for the NZD.
BIGGER PICTURE
The bigger picture outlook for the NZD remains positive for now, but that is largely dependent on what happens to China as the New Zealand economy is also very dependent on trade with China and Australia. However, we don’t want to ignore the clear rangebound price action exhibited by the currency over the past 19 months. For now, given the positive outlook and stretched short positioning, we would favour short-term upside catalysts over trying to chase the currency lower in the short-term.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
Hawkish Fed policy remains a key driver for Dollar strength. With headline inflation >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. STIR markets suggests aggressive policy action pricing a terminal rate of >3.8% by 2Q23 which should be a positive input for the US Dollar . Safe haven flows have also supported the USD as it’s usually inversely correlated to the global economy and global trade, appreciating when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown, accompanied by multi-decade high inflation and synchronized removal of monetary policy stimulus from major economies 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 as economic prospects have deteriorated. Even though US bonds are considered safe havens, the current high inflation 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 benefited from the rush to safety.
POSSIBLE BULLISH SURPRISES
As aggressive Fed policy has been supporting the USD, any incoming data (especially inflation ) that sparks further hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger bullish 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 any incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger bullish 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 and inflation expectations could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
More recently the USD has reacted more cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data slows, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad growth data could trigger bearish reactions in the USD despite its safe haven appeal. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is still close prior highs which acted aslocal 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. Thus, any FOMC comments that suggests more concern about the economy than inflation could trigger bearish reactions in the USD
BIGGER PICTURE
The fundamental outlook for the USD remains bullish 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 growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed as a result of higher risks of recession. Furthermore, given tactical and CFTC positioning, we would prefer deeper pullbacks for new med-term USD longs, but shortterm catalyst can still offer shorter bearish sentiment trades against the current strong bull trend.
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