Credit Suisse has the analysis. This is a good base case. I can easily cook up worse scenarios and not many better!
The past week in the FX market was a textbook phase of various surprises and positioning washouts shocking the system overall, but then ultimately also cementing the ranges that appear to have already been established for some key pairs. Last Thursday, the ECB delivered a 75bp rate cut and left the door wide open for a further 75bp at its next meeting in November too, hitting EUR shorts in the process.
But in a second surprise for the market, Aug US CPI easily beat expectations, leading this time to a purge of EUR longs that had been rapidly established. It appears the market is doomed to replay a constant cycle of birth, death and re-birth for the strong USD theme, with the odds of “enlightenment” that shifts this framework still slim.
Looking at the immediate future, the balance of risk has tilted from concerns about a possible weak US CPI number today to instead thinking about whether a 100bp Fed rate hike is on the slate for the 21 Sep FOMC. In this circumstance, the nearterm path of least resistance for USD is to keep rising, at least until a 100bp Fed rate hike is at least 50% priced in. As a result, we see no reason in the short term to change our key calls end-Q3 calls such as EURUSD 0.9700, USDJPY 145 (with a risk to 150), AUDUSD 0.6550, USDCNH 7.05 and GBPUSD 1.1250. The fact that equity markets are under pressure due to higher US rates, and the VIX is back close to 30 also tends to help the greenback, as a rule. Ex-US G10 central banks will need to keep up or risk a renewed currency rout.
Pro-cyclical trade update: AUDUSD put spread
As for the rest of the pro-cyclical G10 currency cohort, our directional trade efforts of late have been mostly focused on AUD, where we remain long a 27 Sep expiry AUDUSD put spread struck at 0.6800 and 0.6480. At the time of writing, following the large USD rebound triggered by US CPI data, the position is back in the money (spot ref 0.6730).
We continue to see the position as valid and recommend holding on to it. While the shortlived rebound in AUD to around 0.69 has certainly served as a timely reminder of the currency’s pro-risk credentials, we also note that the underlying thesis behind the position – i.e. that the RBA would lag the Fed’s tightening efforts, and that exposure to Chinese growth would offset gains from rising terms of trade – is in fact playing out. Last week’s dovish commentary by RBA Gov Lowe, the disappointing Jul trade balance data and the decline in 2-year AU-US interest rate differentials through 2022 lows to -0.80% all support our view. Looking ahead to the next 2 weeks before expiry, the Aug Australian employment report out today and tomorrow’s Aug macro data out of China stand out as the key idiosyncratic events of note. Market expectations set for generally stronger readings in both sets of numbers continue to suggest the surprise risk remains in the direction that would benefit our position.
