CAD JPY - FUNDAMENTAL DRIVERS
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The BoC did not surprise at their March meeting by hiking rates to 0.50% from 0.25% and continuing the reinvestment phase regarding asset purchases. The bank noted that the Russia/Ukraine war was a new major uncertainty for the economy and that as a result inflation is now expected to be higher in the near-term. They were optimistic about the growth outlook though and reiterated that it expects further interest rate rises will be needed. On the QT side, Gov Macklem noted that around 40% of the bank's bond holdings were due to mature within two years, and suggested that balance sheet could shrink quickly, and also added that they will discuss ending the reinvestment phase and starting QT at the April meeting. The Governor also said he didn’t rule out the potential for 50bsp rate rises as oil is putting upside pressure on CPI , noting that oil prices around $110 per barrel could add another percentage point to inflation . With markets implying close to another 8 hikes this year, we remain cautious on the currency as a slowing US and Canadian economy means the bank could struggle to maintain its current hawkish path in the weeks and months ahead.
2. Intermarket Analysis Considerations
Oil’s impressive post-covid recovery has been driven by many factors such as supply & demand , global demand recovery, and more recently geopolitical concerns. At current prices the risk to demand destruction and stagflation is high, which means we remain cautious of oil in the med-term . Reason for caution: Synchronised policy tightening targeting demand, slowing growth, consensus longs, steep backwardation curve, heightened implied volatility . We remain cautious oil , but geopolitics remain a key driver and focus for Petro-currencies like the CAD (even though the CAD-Oil correlation has been hit and miss).
3. Global Risk Outlook
As a high-beta currency, the CAD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the CAD.
4. CFTC Analysis
Another very bullish positioning signal with Large Specs and Asset Managers increasing longs and Leverage Funds decreasing shorts. With Asset Manager net-longs reaching top 80 percentile levels (2007 base year) we think markets are setting up a similar path compared to April 2021, Oct 2021 and Jan 2022 where markets were too aggressive to price in CAD upside only to see majority of it unwind later. For now, timing is very important, and we’ll wait for a potential hawkish BoC to use outsized strength for AUDCAD & USDCAD long opportunities.
5. The Week Ahead
Hoping for a hawkish BoC and a 50bsp but not for buying opportunities in the CAD. Following decent economic data as well as comments from BoC’s Kozicki (who said the bank will be 'forceful' to fight ‘hot’ inflation ) markets are pricing in close to a 90% chance of a 50bsp hike for this week’s meeting. At their previous meeting, Governor Macklem explained that starting QT would be the logical next step for policy, which means a QT announcement is also on the card and in line with consensus expectations. Given our med-term neutral outlook for the CAD, we are hoping for a hawkish BoC that not only delivers on a 50bsp hike as well as a QT start, but also providing signals of another 50bsp in June. The faster the market moves to price in another 50bsp hike as well as QT, the faster we’ll get to a peak hawkishness scenario. With >9 hikes expected by the end of 2022, a market that fully prices in another 50bsp hike after a hawkish BoC will such a lot of buyers in at the highs and when markets start repricing the curve lower that will set up good shorting opportunities against the CAD.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
No surprises from the BoJ at their March meeting. As usual, the BoJ continued their three decade long easy policy with Governor Kuroda dismissing any chances of starting to debate an exit from the current policy stance. The language and tone were very similar to their prior meeting where the bank remained committed to provide any additional easing if necessary and noted that the current geopolitical situation increases the risks and uncertainty for Japan’s economy. The bank did note that they expect inflation to rise to close to 2% in Q2 as a result of the recent upside in oil prices, but the governor did explain that recent fears of stagflation in places like Japan, EU and US are overdone. Furthermore, Governor Kuroda explained that rates in Japan will remain low and the rate differential between Japan and other major economies are expected to lead to a weaker currency and higher domestic price pressures in the months ahead.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite is jittery. Even though that doesn’t change our med-term bias for the JPY, it does means we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place. In this environment there could be mild upside risks for the JPY, but we should not look at the influence from yields in isolation and also weigh it up alongside underlying risk sentiment and price action in other safe havens.
4. CFTC Analysis
Another increase in net-shorts for Large Specs & Leveraged Funds while Asset Managers trimmed some shorts, but net shorts for all three participant categories remain in the bottom 20% of lows going back to 2008. Even though the JPY’s med-term outlook remains bearish, the recent downside in price and increased net-shorts increases odds of punchy mean reversion with equities, US10Y and oil in focus.
5. The Week Ahead
New Japan fiscal year, US yields and jawboning will be key focus points next week. After the big flush lower in the JPY in recent weeks, there is some question markets over how much part the Japanese fiscal year end played, and now that a new year has started whether that leads to some JPY repatriation. On the yield side, our med-term bias remains bearish on yields given the slowdown we’ve seen in growth data from the US, but with inflation expected to reach close to 9% the inflation story has been in the driver seat. That means, US CPI will be an important focus point for the JPY this week. After the big dip in the JPY, we’ve had numerous official chime in about the weakness, and even though they didn’t exactly push back against it, they’ve clearly taken notice. The bad attention does make any moves into the 130 for USDJPY both interesting and risky for bulls, so watching for further jawboning from Japanese officials will be on the radar as well. On the energy front, it’s important to keep in mind that Japan imports more than 90% of its energy consumption, and research from JP Morgan suggests that a WTI price of $150 could erode Japan’s current account surplus (which is one of the reasons the currency enjoys safe haven appeal), which means yields and oil remain very important drivers.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The BoC did not surprise at their March meeting by hiking rates to 0.50% from 0.25% and continuing the reinvestment phase regarding asset purchases. The bank noted that the Russia/Ukraine war was a new major uncertainty for the economy and that as a result inflation is now expected to be higher in the near-term. They were optimistic about the growth outlook though and reiterated that it expects further interest rate rises will be needed. On the QT side, Gov Macklem noted that around 40% of the bank's bond holdings were due to mature within two years, and suggested that balance sheet could shrink quickly, and also added that they will discuss ending the reinvestment phase and starting QT at the April meeting. The Governor also said he didn’t rule out the potential for 50bsp rate rises as oil is putting upside pressure on CPI , noting that oil prices around $110 per barrel could add another percentage point to inflation . With markets implying close to another 8 hikes this year, we remain cautious on the currency as a slowing US and Canadian economy means the bank could struggle to maintain its current hawkish path in the weeks and months ahead.
2. Intermarket Analysis Considerations
Oil’s impressive post-covid recovery has been driven by many factors such as supply & demand , global demand recovery, and more recently geopolitical concerns. At current prices the risk to demand destruction and stagflation is high, which means we remain cautious of oil in the med-term . Reason for caution: Synchronised policy tightening targeting demand, slowing growth, consensus longs, steep backwardation curve, heightened implied volatility . We remain cautious oil , but geopolitics remain a key driver and focus for Petro-currencies like the CAD (even though the CAD-Oil correlation has been hit and miss).
3. Global Risk Outlook
As a high-beta currency, the CAD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the CAD.
4. CFTC Analysis
Another very bullish positioning signal with Large Specs and Asset Managers increasing longs and Leverage Funds decreasing shorts. With Asset Manager net-longs reaching top 80 percentile levels (2007 base year) we think markets are setting up a similar path compared to April 2021, Oct 2021 and Jan 2022 where markets were too aggressive to price in CAD upside only to see majority of it unwind later. For now, timing is very important, and we’ll wait for a potential hawkish BoC to use outsized strength for AUDCAD & USDCAD long opportunities.
5. The Week Ahead
Hoping for a hawkish BoC and a 50bsp but not for buying opportunities in the CAD. Following decent economic data as well as comments from BoC’s Kozicki (who said the bank will be 'forceful' to fight ‘hot’ inflation ) markets are pricing in close to a 90% chance of a 50bsp hike for this week’s meeting. At their previous meeting, Governor Macklem explained that starting QT would be the logical next step for policy, which means a QT announcement is also on the card and in line with consensus expectations. Given our med-term neutral outlook for the CAD, we are hoping for a hawkish BoC that not only delivers on a 50bsp hike as well as a QT start, but also providing signals of another 50bsp in June. The faster the market moves to price in another 50bsp hike as well as QT, the faster we’ll get to a peak hawkishness scenario. With >9 hikes expected by the end of 2022, a market that fully prices in another 50bsp hike after a hawkish BoC will such a lot of buyers in at the highs and when markets start repricing the curve lower that will set up good shorting opportunities against the CAD.
JPY
FUNDAMENTAL BIAS: BEARISH
1. Monetary Policy
No surprises from the BoJ at their March meeting. As usual, the BoJ continued their three decade long easy policy with Governor Kuroda dismissing any chances of starting to debate an exit from the current policy stance. The language and tone were very similar to their prior meeting where the bank remained committed to provide any additional easing if necessary and noted that the current geopolitical situation increases the risks and uncertainty for Japan’s economy. The bank did note that they expect inflation to rise to close to 2% in Q2 as a result of the recent upside in oil prices, but the governor did explain that recent fears of stagflation in places like Japan, EU and US are overdone. Furthermore, Governor Kuroda explained that rates in Japan will remain low and the rate differential between Japan and other major economies are expected to lead to a weaker currency and higher domestic price pressures in the months ahead.
2. Safe-haven status and overall risk outlook
As a safe-haven currency, the market's risk outlook is usually the primary driver. Economic data rarely proves market moving, and although monetary policy expectations can affect the JPY in the short-term, safe-haven flows are typically more dominant. Even though the market’s overall risk tone saw a huge recovery and risk-on frenzy from the middle of 2020 to the end of 2021, recent developments have increased risks. With central banks tightening policy into an economic slowdown, risk appetite is jittery. Even though that doesn’t change our med-term bias for the JPY, it does means we should expect more risk sentiment ebbs and flows this year, and the heightened volatility can create strong directional moves in the JPY, as long as yields play their part.
3. Low-yielding currency with inverse correlation to US10Y
As a low yielding currency, the JPY usually shares a strong inverse correlation to moves in US yield differentials. Like most correlations, the strength of the inverse correlation between the JPY and US10Y isn’t perfect and will ebb and flow depending on the market environment from both a risk and cycle point of view. With the Fed tilting more aggressive, we think that opens up more room for curve flattening to take place. In this environment there could be mild upside risks for the JPY, but we should not look at the influence from yields in isolation and also weigh it up alongside underlying risk sentiment and price action in other safe havens.
4. CFTC Analysis
Another increase in net-shorts for Large Specs & Leveraged Funds while Asset Managers trimmed some shorts, but net shorts for all three participant categories remain in the bottom 20% of lows going back to 2008. Even though the JPY’s med-term outlook remains bearish, the recent downside in price and increased net-shorts increases odds of punchy mean reversion with equities, US10Y and oil in focus.
5. The Week Ahead
New Japan fiscal year, US yields and jawboning will be key focus points next week. After the big flush lower in the JPY in recent weeks, there is some question markets over how much part the Japanese fiscal year end played, and now that a new year has started whether that leads to some JPY repatriation. On the yield side, our med-term bias remains bearish on yields given the slowdown we’ve seen in growth data from the US, but with inflation expected to reach close to 9% the inflation story has been in the driver seat. That means, US CPI will be an important focus point for the JPY this week. After the big dip in the JPY, we’ve had numerous official chime in about the weakness, and even though they didn’t exactly push back against it, they’ve clearly taken notice. The bad attention does make any moves into the 130 for USDJPY both interesting and risky for bulls, so watching for further jawboning from Japanese officials will be on the radar as well. On the energy front, it’s important to keep in mind that Japan imports more than 90% of its energy consumption, and research from JP Morgan suggests that a WTI price of $150 could erode Japan’s current account surplus (which is one of the reasons the currency enjoys safe haven appeal), which means yields and oil remain very important drivers.
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