Ok, well Goldman has some new “top” FX trades for you – because those always turn out great.
To be sure, the “time to normalize” trade took a hit on Wednesday when Reuters reported that Mario Draghi is apparently getting cold feet about Jackson Hole.
We would suggest that has something to do with escalating geopolitical tension and an especially tumultuous couple of weeks for Donald Trump.
Last week’s VIX spike likely didn’t sit well with policymakers, as it proves that circumstances can quickly conspire to create a palpable sense of angst among traders and investors who are acutely aware that they’re picking pennies in front of steamrollers at this point.
Be that as it may, FX markets are watching like hawks (pun fully intended) for any signs of policy divergence. That means that even the slightest hint that one central bank is moving more quickly than its counterparts has the potential to catalyze an outsized reaction in FX.
For those interested in how Goldman thinks you should play that, you can find some excerpts from their latest below…
New G10 FX Top Trades: Go Long the “Time to Normalize” Markets
Long SEK and NOK vs. EUR and GBP. The cyclical picture in Sweden and Norway differs slightly, but we think both the Riksbank and Norges Bank will begin normalization sooner than markets anticipate. In Sweden, inflation has moved above target, and inflation expectations have rebounded after sliding between 2012 and 2015. A policy rate of -0.5% no longer seems appropriate for this economy—indeed, Sweden screens as having the most extreme policy setting compared with Taylor Rule-implied levels of any market (including the G10 and low-yielding EM). Norway is still dealing with some spare capacity, but growth is now booming: our Current Activity Indicator (on a 3-month moving average basis) moved from 0.8% in December to 3.9% in July—the biggest growth acceleration of any G10 market this year by a large margin. Norges Bank could therefore consider reversing its most recent rate cut, from March 2016, at some point next year. On the funding side, we expect the ECB to hold policy rate expectations steady even as it moves ahead with QE tapering, and we believe the Bank of England will continue to look through above-target inflation due to political uncertainty and long-term risks posed by the Brexit process.
Long AUD and NZD vs. JPY. As in Sweden and Norway, domestic fundamentals differ somewhat in Australia and New Zealand. New Zealand is arguably further along in its cyclical recovery, and domestic demand growth has been very solid. But the general election in September, the transition at the RBNZ (which will involve an interim governor for a 6-month period) and the recent discussion of intervention have introduced new uncertainty in the NZD outlook. In contrast, recent Australian economic news may have been more subdued, but the RBA has expressed relatively less concern about AUD appreciation and is more likely to “lean against the wind” to address financial stability concerns. But while the specifics may differ, we expect both central banks to move policy rates up sooner than markets currently anticipate (note that our RBNZ policy rate forecasts are currently under review)—and both exchange rates to receive a tailwind from favorable global growth. At the same time, monetary policy in Japan looks very unlikely to change for the time being, and yield curve control should amplify the effects of higher global rates on the Yen. If the global economy holds up, we think AUD/JPY and NZD/JPY likely offer significant upside.
Short USD/CAD. The Bank of Canada surprised many investors this year by moving ahead with a rate increase last month—so, unlike the Scandinavian and Antipodean central banks, the BoC has already started the normalization process. But we think markets may still be underestimating the potential for multiple hikes over the next year. Growth in Canada has been very solid: real GDP increased by 3.7% in Q1 and is on pace for a similar gain in Q2 (our CAI has averaged just under 4% this year as well), and this spring (and again in July) the BoC shifted forward the point at which the output gap would close. Inflation is still below target, but policymakers appear more focused on diminished spare capacity and, to some degree at least, financial stability risks. With the unemployment rate falling to just 6.3% in July and house prices still very elevated, we doubt the BoC will be inclined to pause any time soon. As a result, we think USD/CAD can head lower again after retreating over the last few weeks.
A word (or five) of caution here.
First of all Sweden’s monetary policy is inextricably bound up with ECB policy (more on that here). And they are laser-focused on their inflation target. It seems unlikely that they will move too aggressively if Draghi doesn’t move in the same direction.
With AUD, do note that after the last RBA minutes (not the ones we got this week, the release before that) we saw a “bigly” aussie rally and policymakers including Lowe himself quickly moved to temper market expectations (more here).
On CAD, we’re sympathetic to the upbeat growth outlook, but let’s not forget about the massive housing bubble and do note that the loonie is subject to considerable risk from crude.
Anyway, don’t get “muppetized”.