Canadian Dollar
In this Special Report, BCA’s Foreign Exchange Strategy and Global Fixed Income Strategy teams argue that as the lagged impact of higher interest rates hits the Canadian economy, what will initially appear as a potential hard landing will morph into a mild slowdown. During the process, Canadian government bonds will outperform, and the CAD will drop, setting the stage for a coiled-spring rebound.
In this Strategy Insight, we go over the RBA’s recent decision and the implications of its hawkish message for AUD trades.
In this Strategy Insight, we go over the RBA’s recent decision and the implications of its hawkish message for AUD trades.
This week, we articulate what the actions of the three major central banks that met (Fed, ECB and BoE) mean for currency markets. This is within the context of our analysis of the latest data releases in the G10, that allows us to calibrate currency strategy.
This week, we look at the latest data releases in the G10, along with implications for all the major currencies.
Commodity currencies have been rather resilient, despite the broad rise in the dollar this year. In our view, we are about to experience a big rotation in commodity currency market performance at the crosses, from NZD, to CAD and finally to AUD.
In this report, we look at the possibility of a dollar decline during any pending recession. In our view, the evidence is mixed. We are probably in one of the most anticipated recessions in recent history, and the dollar has risen a lot. But the dollar also tends to rise during most recessions. We recommend a neutral stance on the DXY, with a bet on some trades at the crosses.
In this report, we identify 5 key signposts that will mark a turn in the dollar. These include technical conditions, foreign real interest rates, US (and global) yield curves, Chinese economic conditions and geopolitics. We then assess whether it is time to short the dollar.
Dear client, Next week’s report will be on European assets, authored by my colleague Mathieu Savary. We will send that to you Monday, September 26. In that report, Mathieu looks at the European energy market in depth, and concludes the eurozone will survive the winter, but with critical tests in the coming weeks. Mathieu suggests the euro could touch 0.965 in this process. I trust you will find the report insightful. Our regular publication will resume on October 7. Kind regards, Chester Ntonifor, Foreign Exchange Strategist Executive Summary Real Yields Still Favor The Dollar Every central bank is stepping up its hawkish rhetoric, but the Fed is still being perceived as having the moat to deliver the most aggressive rate hikes. As long as the market believes the US economy will maintain its superstar status, the dollar has upside. That said, financial conditions are tightening meaningfully in the US. Meanwhile, US inflation has peaked relative to other G10 countries, suggesting the market could price a less aggressive path for Fed interest rates, relative to other central banks. Narrowing interest rate differentials will diffuse US dollar momentum. The big risk of leaning against dollar strength is a recession that spreads from Europe, the UK, and China and becomes global. The dollar tends to do well during recessions, even after a prolonged bout of strength. Our core trades remain at the crosses: short EUR/JPY and long EUR/GBP. We are looking to buy NOK/SEK on further weakness and our limit buy on AUD was triggered. Bottom Line: Stay neutral the dollar for now but conditions for a short position continue to accrue. Feature We last published our Month-In-Review report on August 12th, suggesting inflation was still strong globally, and central banks will zone in on their mandate of cooling prices. Since then, bankers have been very busy. The Reserve Bank of New Zealand (RBNZ) hiked rates by 50bps on August 17. At 3%, New Zealand now has one of the highest policy rates in the G10. The Norges Bank has hiked rates twice since, by 50bps. The policy rate now stands at 2.25%. The Reserve Bank of Australia (RBA) hiked policy rates by 50bps on September 6. The Bank of England (BoE) hiked by 50 bps on September 16th, albeit, below market expectations. The Riksbank hiked rates by 100 bps on September 20. In a rare occurrence, Sweden now has higher rates than the eurozone. The European Central Bank (ECB), the Fed, and the Swiss National Bank (SNB) recently hiked rates by 75 bps. Finally, as a lone wolf, the Bank of Japan (BoJ) stayed pat, but has massively intervened to stabilize the drawdown in the yen. The message is clear, global central banks are on a path to cool inflation and regain credibility. In recent weeks, the Fed has been one of the most aggressive in hiking policy rates (Chart 1). As a result, the 10-year US Treasury yield has risen from 3% to 3.7% in the last month, among the most aggressive in the G10 (Chart 2). Other central banks are also catching up as inflation accelerates outside the US. Specifically, US price gains have peaked relative to their G10 counterparts (Chart 3). Faster rising yields and slowing inflation means that relative real yields continue to bid the dollar higher (Chart 4). Chart 1The Fed Is Very Hawkish Chart 2Interest Rates Rising Meaningfully In The US Chart 3Other Central Banks Need To Play Catch Up Chart 4Real Yields Still Favor The Dollar This backdrop is highly deflationary. Tightening policy while economic growth is slowing is a toxic cocktail. It explains why the dollar continues to command a bid, as markets believe most central banks cannot engineer a soft landing. The dollar does well in hard landings. In the next few sections, we cover the important data releases over the last month in our universe of G10 countries, and the implications for currency strategy. What is clear is that most foreign central banks are committed to their tightening campaign, which argues for a neutral stance towards the DXY for now, with a view to sell after/if global central banks engineer a recession. US Dollar: Stealth Strength Chart 5US Dollar: Stealth Strength The dollar DXY index is up 17.4% year to date. Over the last month, the DXY index is up 3.6% (panel 1). The market focus for the dollar will remain the jobs and employment report. Job gains remain robust. In August, the US added 315K jobs. While the unemployment rate rose to 3.7%, the participation rate also rose from 61.2% to 62.4% (panel 2). Wages continue to rise. Average hourly earnings came in at 5.2% year-on-year in August. The Atlanta Fed wage growth tracker continues to edge higher across all income cohorts (panel 3). Headline inflation decelerated to 8.3% in August, but the core measure did accelerate from 5.9% to 6.3% (panel 4). On September 21, the Fed increased interest rates by 75bps, as expected. Inflows into US assets remain strong. According to TIC data, the US saw $154 bn of inflows in July. Higher interest rates are taking a toll on the housing market. Building permits fell sharply in August, which makes the rebound in housing starts look fleeting. Financial conditions are tightening in the US. From a currency perspective, the dollar is overbought, and sentiment is very bullish (panel 5). That said, as a momentum currency, the dollar will continue to perform well if risk assets fall to the wayside. We remain neutral in the short term, though valuation keeps us bearish over a long-term horizon. The Euro: Undershooting Parity Chart 6The Euro: Undershooting Parity The euro is down 14.2% year to date. Over the last month, the euro is down 2.5%. As we go to press, the euro has broken below 0.97. The main risk for the eurozone remains stagflation: The ZEW Expectations Survey was at -60.7 in September, a bearish development for the euro (panel 1). Consumer confidence deteriorated further in September, to -28.8 for the eurozone (the European Commission measure). The deterioration has been consistent among member countries (panel 2). Inflation remains sticky in the eurozone. Headline CPI accelerated to 9.1% in August. PPI in the euro area was at 37.9% in July, an acceleration from the June reading (panel 3). The trade balance continues to deteriorate, hitting - €40.3bn in July. The preliminary PMI read for September was at 48.5 from 49.6, suggesting the eurozone is already in recession (panel 4). The Sentix confidence index deteriorated in September to -31.8. This remains above the 2020 low but is rapidly catching up to the downside. Despite the above data prints, the ECB lifted interest rates by 75 bps on September 8th. The ECB continues to fight soaring inflation and will need to engineer a recession in the eurozone to achieve its mandate. This is a key risk for the euro. We continue to sell the EUR/JPY cross, while we remain constructive on EUR/GBP (panel 5). Our initial line in the sand was 0.98 for the euro, but as my colleague will argue next week, it could substantially undershoot this level. Stand aside for now. The Japanese Yen: Currency Intervention Chart 7The Japanese Yen: Currency Intervention The Japanese yen is down 19.71% year-to-date. The yen hit an intra-day low of 145.8, forcing intervention by Japanese authorities. That has assuaged selling pressure. Meanwhile, economic data out of Japan has been on the mend. The Eco Watcher’s survey showed that sentiment improved in August. Current conditions rose from 43.8 to 45.5. The outlook component also rose from 42.8 to 49.4. The trade balance in Japan continues to deteriorate, due to soaring energy costs. That said, exports are holding up, rising 22% year-on-year in August (panel 2). Machine tool orders also ticked up. Labor market conditions remain robust. The job-to-applicant ratio rose to 1.29% in July. Inflation is picking up in Japan (panel 3). The nationwide CPI report for august showed an increase in the core-core measure from 1.2% to 1.6%. Headline CPI rose from 2.6% to 3%. The Bank of Japan continues to keep monetary policy on hold. However, the depreciating yen triggered intervention from Japanese authorities. We are short EUR/JPY, a trade that continues to pan out and a call option on a BoJ shift. While inflation expectations remain sticky in Japan, they could overshoot (panel 4). Our thesis is that short-term investors should stand aside on the yen, but longer-term buyers are in for a bargain. The yen is cheap, a favorite short, and the Japanese economy could surprise to the upside (panel 5). British Pound: Towards Parity? Chart 8British Pound: Towards Parity? The pound is down 19.59% year to date. The depreciation in the pound has picked up pace, with cable now trading near 1.1 (panel 1). The next level of support is the 1985 low of 1.08. Economic data in the UK continues to disappoint. CPI came in at 9.9% in August. The RPI came in at 12.3%. PPI was at 24%. According to BoE forecasts, we will hit double digits in CPI prints soon (panel 2). Nationwide house price inflation remained strong in August, rising 10% year-on-year (panel 3). Retail sales excluding auto and fuel fell 5.4% year-on-year in August (panel 4). Trade data remains weak. The current account is close to a record low (panel 5). The external balance remains negative for the pound. With the new fiscal package of tax cuts, gilt yields are hitting new highs and the cable is selling off. This is because more demand will depress real rates in the UK, if not accompanied by productivity gains. We are maintaining our long EUR/GBP trade. On cable, downside remains but we will be buyers at 1.05. Australian Dollar: A Contrarian Trade Chart 9Australian Dollar: A Contrarian Trade The AUD is down 10.14% year-to-date (panel 1). Over the last month, the AUD is down 5.68%. The RBA hiked interest rates by 50bps in August, lifting the official cash rate to 2.35%. We believe further rate increases remain likely. Inflation is accelerating in Australia, as the labor market tightens (panel 2). 59K jobs were added in August. The participation rate also ticked up from 66.4% to 66.6%. While the unemployment rate rose (panel 3), labor market conditions remain the strongest in decades (panel 4). Monetary policy continues to have the desired effect, as home loan issuance declined 7% in July. The manufacturing sector remains strong, with the August manufacturing PMI coming in at 53.8. The external environment continues to weigh on the AUD. In July, the trade balance came in lower than expected at -A$8.7bn vs a forecast of A$14.5bn (panel 5). This was largely driven by commodity prices rolling over and slowing Chinese demand. The headwinds are likely to persist in the near term. That said, our limit buy on AUD/USD was triggered at 0.665. In our view, the AUD already embeds a lot of bad news. New Zealand Dollar: Stay Short At The Crosses Chart 10New Zealand Dollar: Stay Short At The Crosses The NZD is down 15% year-to-date (panel 1). Over the last month, the NZD is down 6.8%. The Reserve Bank of New Zealand raised its official cash rate (OCR) in August by 50 bps to 3.0%. The RBNZ cited high core inflation (panel 2) and scarce labor resources as the primary reasons and guided towards tighter monetary policy. Monetary policy continues to be having the desired effect across interest rate sensitive areas of the economy. Home sales continued to slow in August, with REINZ home sales down 18.3% year-over-year. Home price growth is also cratering nationwide (panel 3). There is some evidence of a soft landing in New Zealand. ANZ consumer confidence rose to -85.4 from -81.9. Business confidence also bounced to -47.8 (panel 4). The Business NZ PMI expanded to 54.9 in August. The external sector however continues to suffer from headwinds. Dairy prices, circa 20% of exports, remained flat in August after falling sharply at the start of the month. New Zealand’s 12-month trailing trade balance remains in deficit. As the NZD is heavily dependent on international trade, headwinds from a slowing Chinese economy will continue to weigh on the currency. We are bearish NZD at the crosses, though it will hold up if the dollar rolls over. Canadian Dollar: A Hawkish BoC Chart 11Canadian Dollar: A Hawkish BoC The CAD is down 7.5% year to date. Over the last month, it is down 4%. The tightening campaign by the BoC is having the desired effect on economic data. Beginning with the labor market, the unemployment rate ticked up in August to 5.4% (panel 2), the highest level since February of this year. August also marks the third consecutive month of job losses, albeit with a higher labor force participation rate at 64.8%. While inflation in Canada appears to have peaked, it remains sticky. Headline CPI fell to 7% from 7.6%. Core inflation has also declined to 5.8% (panel 3). The housing market continues to slow. Building permits and housing starts are rolling over (panel 4). Notably, building permits declined 6.6% month-over-month against a forecast decline of 0.5%. Housing starts in August fell to 267.4K from 275.2K in July. The incoming prints are a “carte blanch” for the BoC to continue its tightening campaign. In August, it increased its policy rate to 3.25% (panel 5). More hikes are likely forthcoming. The OIS curve shows a peak in the overnight rate at 4% in February next year (panel 5). Ultimately, the CAD benefits from the terms of trade boom (panel 1) and an eventual decline in the US dollar. But as long as the USD remains strong, CAD faces downside. Swiss Franc: A Haven Chart 12Swiss Franc: A Haven The Swiss Franc is down 7% year-to-date. EUR/CHF broke below 0.95, and the risk is that this level is tested again in the coming days (panel 1). We penned a report earlier this year arguing that Switzerland was an oasis of optimism: Inflation is accelerating, but still sits at 3.5% for August (panel 2). The decline in import prices is encouraging following franc strength (panel 3). Sight deposits are rolling over suggesting the SNB is not intervening to weaken the franc (panel 4). We are buyers of CHF at the crosses. Norwegian Krone: Buy On Weakness Chart 13Norwegian Krone: Buy On Weakness The NOK is down 19.7% year-to-date and 8% over the last month (panel 1). Inflation remains high in Norway. In August, CPI grew 6.5% year-on-year (panel 2). PPI including oil rose 77.3%. The housing market will bear the brunt of rate hikes. Household indebtedness (panel 3), makes the task of policy calibration challenging. Consumer confidence fell to a new low in the third quarter. The good news is that economic activity is robust on the back of Norway’s energy advantage. The current account remains in surplus (panel 5). If global risk sentiment picks up, the krone will be a jewel in the G10. If the risk appetite remains muted, NOK will face strong headwinds. Swedish Krona: A Beta Play On The Euro Chart 14Swedish Krona: A Beta Play On The Euro SEK is down 23.9% year-to-date. Over the last month, the krona is down 5.6% (panel 1). The Riksbank surprised markets by raising rates by 1% on September 20th (panel 5). Critically, rising inflation was the catalyst. Headline inflation accelerated from 8.5% to 9.8% in August. This is well above target (panel 3). The economic tendency survey rolled over from 101.3 to 97.5. A strong PMI has been a beacon of hope in Sweden but the headline figure dipped from 53.1 to 50.6 in August. The housing market continues to soften (panel 2). The Riksbank’s latest estimate sees a 16% decline in prices this year. Much like the NOK, the Swedish krona will gyrate along the path of the broad trade-weighted USD. Fundamentally, the krona remains more vulnerable to external shocks due to higher energy dependency and a strong dollar. But it is also incredibly cheap. We are looking for opportunities to be long SEK at the crosses. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Trades & Forecasts Strategic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Forecast Summary
Listen to a short summary of this report. Executive Summary Chart 1The Dollar Has Broken Below The First Line Of Support The softer CPI print in the US boosted growth plays and pushed the DXY index below its 50-day moving average (Feature Chart). This suggests CPI numbers will remain the most important print for currency markets in the coming weeks and months. If US inflation has peaked, then the market will price a less aggressive path for Fed interest rates, which will loosen support for the dollar. At the same time, other G10 central banks are still seeing accelerating inflation. This will keep them on a tightening path. This puts the DXY in a tug of war. On the downside, the Fed could turn less hawkish. On the other hand, currencies such as the EUR, GBP and even SEK face high inflation but deteriorating growth. This will depress real rates. Within this context, the most attractive currencies are those with relatively higher real rates, and a real prospect of a turnaround in growth. NOK and AUD stand out as potential candidates. Our short EUR/JPY trade has been performing well in this context. Stick with it. RECOMMENDATIONS INCEPTION LEVEL inception date RETURN Short EUR/JPY 141.20 2022-07-21 3.29 Bottom Line: Our recommended strategy is a neutral dollar view over the next three months, until it becomes clear inflation has peaked and global growth has bottomed. Feature The DXY index peaked at 108.64 on July 14 and has dropped to 105.1 as we go to press. There have been two critical drivers of this move. First, the 10-year US Treasury yield has fallen from 3.5% to 2.8%. With this week’s all important CPI release, which showed a sharp deceleration in the headline measure, bond yields may well stabilize at current levels for a while. Second, the drop in energy prices has boosted the JPY, SEK and EUR, which are heavily dependent on imported energy. Related Report Foreign Exchange StrategyA Montreal Conversation On FX Markets Another development has been happening in parallel – as US inflation upside surprises have crested, so has the US price impulse relative to its G10 counterparts (Chart 1). To the extent that this eases market pricing of a hawkish Fed (relative to other G10 central banks), it will continue to diminish upward pressure on the dollar. Much will depend on the incoming inflation prints both in the US, and abroad. With the DXY having broken below its 50-day moving average, the next support level is at 103.6. This is where the 100-day moving average lies, which the dollar tested twice this year before eventually bouncing higher (Chart 2). The next few sections cover the important data releases over the last month in our universe of G10 countries, and implications for currency strategy. What is clear is that most foreign central banks are committed to their tightening campaign, which argues for a neutral stance towards the DXY for now. Chart 1US Inflation Momentum Has Rolled Over Chart 2The Dollar Has Broken Below The First Line Of Support US Dollar: Consolidation Chart 3The Conditions For A Fed Hike Remain In Place The dollar DXY index is up 10% year to date. Over the last month, the DXY index is down 2.1% (panel 1). Incoming data continues to make the case for a strong dollar. Job gains are robust. In June, the US added 372K jobs. The July release was even stronger at 528K jobs. This pushed the unemployment rate to a low of 3.5% (panel 2). Wages continue to soar. Average hourly earnings came in at 5.2% year-on-year in July. The Atlanta Fed wage growth tracker continues to edge higher across all income cohorts (panel 3). The June CPI print was above expectations at 9.1% for headline, with core at 5.9%. The July print for headline that came out this week was 8.5%, below expectations of 8.7%. At 5.9%, the core measure is still well above the Fed’s target (panel 4). June retail sales remained firm, but consumer sentiment continues to weaken. While the University of Michigan current conditions index increase from 53.8 to 58.1 in June, this is well below the January 2020 level of 115. Correspondingly, the Conference Board consumer confidence index fell from 98.7 to 95.7 in July. On June 17, the Fed increased interest rates by 75bps, as expected. The US entered a second consecutive quarter of GDP growth contraction in Q2, falling by an annualized 0.9%. The ISM manufacturing index was flat in July suggesting Q3 GDP is not starting on a particularly strong foot. The Atlanta Fed Q3 GDP growth tracker is, however, printing 2.5%. Unit labor costs are soaring, rising 10.8% in Q2. This is sapping productivity growth, which fell 4.6% in Q2. The key for the dollar’s outlook is the evolution of US inflation and the labor market. For now, inflation remains sticky, and wages are rising. Meanwhile, labor market conditions remain robust. This will keep the Fed on a tightening path in the near term. We initially went short the DXY index but were stopped out. We remain neutral in the short term, though valuation keeps us bearish over a long-term horizon. The Euro: A European Hard Landing Chart 4The Euro Is At Recession Lows The euro is down 9.2% year to date. Over the last month, the euro is up 2.7%, having faced support a nudge below parity. Incoming data continues to suggest weak economic conditions, with a stagflationary undertone: The ZEW Expectations Survey for July was at -51.1, the lowest reading since 2011 (panel 1). The current account remains in a deficit, at -€4.5bn in May. Consumer confidence continues to plunge. The July reading of -27 is the worst since the 2020 Covid-19 crisis (panel 2). Despite the above data releases, the ECB surprised markets by raising rates 50bps. CPI continues to surprise to the upside. The preliminary CPI print for July came in at 8.9%, well above the previous 8.6% print. PPI in the euro area was at 35.8% in June, a slight decline from the May reading (panel 3). The German Ifo business expectations index fell to 80.3 in July. Historically, that has been consistent with a manufacturing PMI reading of 45 (panel 4). The Sentix confidence index stabilized in August but remains very weak at -25.2. This series tends to be trending, having peaked in July last year. We will see if the next few months continue to show stabilization. The ECB mandate dictates that it will continue to fight soaring inflation. As such, it may have no choice but to generate a Eurozone-wide recession. This is the key risk for the euro since it could push EUR/USD below parity again. We continue to sell the EUR/JPY cross. In a risk-off environment, EUR/JPY will collapse. In a risk-on environment, like this week, the yen can still benefit since it is oversold. Meanwhile, investors remain overwhelmingly bearish (panel 5). The Japanese Yen: Quite A Hefty Rally Chart 5Some Green Shoots In Japan The Japanese yen is down 13.4% year-to-date, the worst performing G10 currency (panel 1). Over the last month, the yen is up 3.3%. Incoming data in Japan has been worsening as the rising number of Covid-19 cases is hitting mobility and economic data. According to the Eco Watcher’s survey, sentiment among small and medium-sized Japanese firms deteriorated in July. Current conditions fell from 52.9 to 43.8. The outlook component also declined from 47.6 to 42.8. Machine tool order momentum, one of our favorite measures of external demand, continues to slow. Peak growth was at 141.9% year-on-year in May last year. The preliminary reading from July was at 5.5% (panel 2). Labor cash earnings came in at 2.2% year-on-year, a positive sign. Household spending also rose 3.5%. Rising wages could keep inflation momentum rising in Japan (panel 3). On that note, the Tokyo CPI report for July was also encouraging, with an increase in the core-core measure from 1% to 1.2%. The Tokyo CPI tends to lead nationwide measures. The labor market remains robust. Labor demand exceeds supply by 27%. The Bank of Japan kept monetary policy on hold on July 20th, a policy move that makes sense given incoming data. The BoJ still views a large chunk of inflation in Japan as transitory. For inflation to pick up, wages need to rise. While they are rising, inflation expectations remain well anchored, suggesting little rationale for the BoJ to shift (panel 4). That said, the yen is extremely cheap after being the best short this year (panel 5). British Pound: Coiled Spring Below 1.20? Chart 6Cable Is Vulnerable The pound is down 9.8% year to date. Over the last month, the pound is up by 2.5%. Sterling broke below a soft floor of 1.20, but quickly bounced back and is now sitting at 1.22, as sentiment picked up (panel 1). We find the UK to have an even bigger stagflation problem than the eurozone. CPI came in at 9.4% in June. The RPI came in at 11.8%. PPI was at 24%. All showed an acceleration from the month of May (panel 2). Nationwide house price inflation has barely rolled over unlike other markets, increasing from 10.7% in June to 11% in July. The Rightmove national asking price was 9.3% higher year-on-year in July, compared to 9.7% in June (panel 3). Meanwhile, mortgage approvals have been in steady decline over the last two years, which points toward stagflation. Retail sales excluding auto and fuel fell 5.9% year-on-year in June, the weakest reading since the Covid-19 crisis. Consumer confidence is lower than in 2020 (panel 4). Trade data continues to be weak, which has dipped the current account towards decade lows (panel 5). The external balance is the biggest driver of the pound, given the huge deficit. The above environment has put the BoE in a stagflationary quagmire. Last week, they raised rates by 50 bps suggesting inflation is a much more important battle than growth. Politically, the resignation of Prime Minister Boris Johnson, and broader difficulties for the Conservative Party, is fueling sterling volatility. We are maintaining our long EUR/GBP trade as a bet that at 1.03, the euro has priced in a recession (well below the 2020 lows), but sterling has not. On cable, 1.20 will prove to be a long-term floor but it will be volatile in the short term. Australian Dollar: A Contrarian Play Chart 7Relatively Solid Domestic Conditions In Australia The AUD is down 2.3% year-to-date. Over the last month, the AUD is up 5.3%. AUD is fast approaching its 200-day moving average. If that is breached, it could signal that the highs of this year, above 76 cents, are within striking distance (panel 1). Inflation is accelerating in Australia. In Q2, the inflation reading was 6.1%, while the trimmed-mean and weighted-median measures were above the central bank’s 1-3% band (panel 2). As a result, the RBA stated the benchmark rate was “well below” the neutral rate. It increased rates by an additional 50bps in August, lifting the official cash rate to 1.85%. Further rate increases are likely. There are a few reasons for this. First, labor market conditions are the most favorable in decades. In June, unemployment reached 3.5%, its lowest level in 50 years, against a consensus of 3.8% (panel 3). The participation rate also increased to 66.8% in June from 66.7%, which has pushed the underutilization rate to multi-decade lows (panel 4). Despite this, consumer confidence continued its decline in August, dropping to 81.2 from 83.8. A pickup in Covid-19 cases and high consumer prices are the usual suspects. Beyond the labor market, monetary policy seems to be having the desired effect. Demand appears to be slowing as retail sales grew 0.2% month-on-month in June from 0.9%. Home loan issuance declined by 4.4% in June, driven by a 6.3% decline in investment lending. House price growth continued to decline in July, particularly in densely populated regions like Sydney and Melbourne. The manufacturing sector remains strong, with July PMI coming in at 55.7, suggesting the RBA might just be achieving a soft landing in Australia. The external environment was largely favorable for the AUD in June, as the trade balance increased substantially by A$17.7bn with commodities rallying early in the month. However, commodity prices are rolling over. The price of iron for example, is down 24% from its peak in June. This will likely weigh on the trade balance going forward (panel 5). A weakening external environment are near-term headwinds for the AUD, but we will be buyers on weakness (panel 6). New Zealand Dollar: Least Preferred G10 Currency Chart 8Near-Term Risks To NZD The NZD is down 6.1% this year. Over the last month, it is up 5% (panel 1). The Reserve Bank of New Zealand raised its official cash rate (OCR) in July by 50bps to 2.5%, in line with market expectations. Policymakers maintained their hawkish stance and guided towards increased tightening until monetary conditions can bring inflation within its target range of 1-3%. Inflation rose in Q2 to 7.3% from a 7.1% forecast, largely driven by rising construction and energy prices (panel 2). As of the latest data, monetary policy appears to be continuing to have the desired effect on interest rate sensitive parts of the economy. REINZ home sales declined 38.1% year-on-year in June. Home price growth continues to roll over (panel 3). The external sector continues to slow. Dairy prices, circa 20% of exports, saw a 12% drop in early August after remaining flat in July. The 12-month trailing trade balance remains in deficit. This is most likely due to a substantial slowdown in Chinese economic activity, given that China is an important trade partner with New Zealand. What is important is that the RBNZ’s “least regrets” approach seems to be working. Despite a cooling economy, sentiment seems to be stabilizing. ANZ consumer confidence improved to 81.9 in July from 80.5. Business confidence also improved to -56.7 from -62.6 (panel 4). Ultimately, the NZD is driven by terms of trade, as well as domestic conditions (panels 1 and 5). Thus, short-term headwinds from a deteriorating external sector do not make us buyers of the currency for now, though a rollover in the dollar will help the kiwi. Canadian Dollar: Lower Oil, Hawkish BoC Chart 9The BoC Will Stay On A Hawkish Path The CAD is down 1.2% year to date. Over the last month, it is up 1.8%. The Canadian dollar did not fully catch up to oil prices on the upside. Now that crude is rolling over, CAD remains vulnerable, unless the dollar continues to stage a meaningful decline (panel 1). Canadian data has been rather mixed over the last month. For example: There have been two consecutive months of job losses. This is after a string of positive job reports. In July, Canada lost 31K jobs. In June, it lost 43K. The reasons have been mixed, from women dropping out of the labor force, to lower youth participation (the participation rate fell), but this is a trend worth monitoring (panel 2). CPI growth remains elevated and is accelerating both on headline and core measures(panel 3). Building permits and housing starts have started to roll over, as house price inflation continues to lose momentum. June housing starts were at 274K from 287.3K. June building permits also fell 1.5% month-on-month though annual inflation is still outpacing house price growth (panel 4). The Canadian trade balance is improving, hitting a multi-year high of C$5.05 bn in June. This has eased the need for foreign capital inflows. The BoC raised rates 100bps in July, the biggest interest rate increase in one meeting among the G10. Unless the labor market continues to soften, the BoC will continue to focus on inflation, which means more rate hikes are forthcoming. The OIS curve is pricing a peak BoC rate of 3.6% in 9 months (panel 5). Two-year real rates are still higher in the US compared to Canada. And the loonie has lost the tailwind from strong WCS oil prices. As such, unless the dollar softens further, the loonie will remain in a choppy trading pattern like most of this year. Swiss Franc: A Safe Haven Chart 10The Franc Will Remain Strong Against The Euro For Now CHF is down 3.2% year-to-date and up 4.3% in the past month. The Swiss franc has been particular strong against the euro, with EUR/CHF breaching parity (panel 1). Switzerland remains an island of relative economic stability in the G10. Although slowing, the manufacturing PMI was a healthy 58 in July. The trade surplus was up to CHF 2.6bn in June, despite a strong franc. While most European countries are preparing for a tough winter with energy rationing, prospects for Switzerland, which derives only 13% of its electricity from natural gas, look more favorable. Still, as a small open economy, Switzerland is feeling the impact of global growth uncertainty. The KOF leading indicator dropped to 90.1 in August with a sharp decline in the manufacturing component. This broader measure suggests the relative resilience of the manufacturing sector might not last long (panel 2). Consumer confidence also fell to the lowest level since the onset of the pandemic. Swiss headline inflation stabilized at 3.4% in July. The core measure rose slightly to the SNB’s 2% target (panel 3). The UBS real estate bubble index rose sharply in Q2, suggesting inflation is not only an imported problem. Labor market conditions also remain tight, with the unemployment rate at 2%, a two-decade low. The SNB will continue to embrace currency strength while inflation risks persist (panel 4), as can be seen by the decline in sight deposits and FX reserves (panel 5). The market is still pricing in another 50 bps hike in September although August inflation data that comes out before the meeting will likely be critical for that decision. CHF is one of the most attractive currencies in our ranking. Despite the recent outperformance, CHF is still down year-to-date against the dollar. A rise in safe-haven demand, and a possible energy crunch in winter will be supportive, especially against the euro. Norwegian Krone: Oil Fields Are A Jewel Chart 11NOK Will Reap Dividends From Energy Exports NOK is down 7.4% year-to-date and up 7.1% over the last month. It is also up 4.2% versus the euro, despite softer oil prices (panel 1). Inflation in Norway continues to accelerate. In July, CPI grew 6.8% year-on-year, above the market consensus and the Norges Bank’s forecast. Underlying inflation jumped sharply to an all-time high of 4.5%, compared to the Bank’s 3.2% forecast made just over a month ago (panel 2). These figures are adding pressure on the central bank to increase the pace of interest rate hikes, with 50bps looking increasingly likely at the meetings in August and September. NOK jumped on the inflation news. The housing market is starting to show signs of slowing with prices down 0.2% on the month in July, the first decrease since December. This, together with household indebtedness (panel 3), makes the task of policy calibration challenging. Our bias is that a persistently tight labor market and strong wage growth (panel 4) will allow the bank to focus on inflation. Economic activity remains robust in Norway but is softening. The manufacturing PMI fell to 54.6 in July, while industrial production was down 1.7% month-over-month in June. Consumer demand remains frail with retail sales and household consumption flat in June from the previous month. On a more positive note, trade surplus remains near record levels and is likely to stay elevated as high European demand for Norwegian energy is likely to last at least through the winter (panel 5). As global risk sentiment picked up, the krone became the best performing G10 currency over the past month. If the risk appetite reverses, the currency is likely to feel some turbulence. Swedish Krona: Cheap, But No Catalysts Yet Chart 12SEK = EUR On Steroids SEK is down 10% year-to-date and up 5.6% over the past month. The vigorous rebound highlights just how oversold the Swedish krona is (panel 1). The Swedish economy grew 1.4% in Q2 from the previous three months, rebounding from a 0.8% contraction in the first quarter. This is impressive, given high energy prices and a slowdown in global economic activity. Going forward, growth is likely to slow. In July, the services and manufacturing PMIs declined, and consumer confidence fell sharply to the lowest reading in almost 30 years. Retail sales were down 1.2% month-on-month in June. The housing market is also feeling the pain of rising borrowing costs (panel 2). The Riksbank’s latest estimate sees a 16% decline in prices by the end of next year. For now, inflation is still accelerating in Sweden. CPIF, the Riksbank’s preferred measure, increased from 7.2% to 8.5% in June. Headline inflation rose from 7.3% to 8.7% (panel 3). Headline inflation is likely to decline in July, given the drop in the price component of the PMIs, but inflation will remain well above target. This will keep real rates weak (panel 4). This suggests that the Riksbank is facing the same conundrum as the ECB: accelerate policy tightening and tip the economy towards recession or remain accommodative and risk inflation becoming more entrenched. Our bias is that the Riksbank is likely to frontload rate hikes as currently priced in the OIS curve, with a 50 bps hike in September, ahead of major labor union wage negotiations (panel 5). Much like the NOK, the Swedish krona rebounded strongly in the past month on global risk-on sentiment. Fundamentally, the krona remains more vulnerable to external shocks due to higher energy dependency and a strong dollar. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Artem Sakhbiev Research Associate artem.sakhbiev@bcaresearch.com Thierry Matin Research Associate thierry.matin@bcaresearch.com Trades & Forecasts Strategic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Forecast Summary