G10 FX Weekly: Antipodean and Scandi Trends to Accelerate Next Month

Summary

• As with the rest of the G10 FX and rates space, Antipodean and Scandi markets have been rangebound in July-August as investors await a decisive September and Q4 for developed market central banks.
• We expect the rangebound price action to hold in Aussie, Kiwi, Norwegian and Swedish markets in the next week or two.

Market Implications

• Once activity picks up next month, we expect the trades we liked on 6 July to keep performing into yearend.
• Specifically, we expect Australian and New Zealand 2-year yields to continue their downward march, after both peaked year-to-date (YTD) last month.
• In Scandi FX, we expect the Norwegian krone (NOK) to outperform the Swedish krona (SEK), with NOK/SEK to rise back to the top of its one-year range by yearend.

Introduction

Price action in the G10 FX and rates space has been mostly choppy and trendless through July and August. This week, we explore the Antipodean and Scandinavian markets, which have also been rangebound.

The Reserve Bank of Australia (RBA), Reserve Bank of New Zealand (RBNZ), Norway’s Norges Bank and Sweden’s Riksbank will all set policy in the next 5-6 weeks, which should move markets.

We expect the trends we wrote about before the summer lull to re-emerge in September and Q4. Accordingly, we still like being long in the 2-year Australian and New Zealand rate spaces while being bullish NOK/SEK.

These positions have all performed well since we initiated them on 6 July. We expect the same into yearend.  

RBA, RBNZ, Norges Bank and Riksbank State of Play

Despite these rangebound markets, Antipodean and Scandinavian central banks have been active with rate decisions and messaging since our July article. Furthermore, policy expectations for September suggest an important period into yearend.

The RBA

The RBA met on 1 August, surprising investors by keeping its policy rate (Cash Rate) on hold at 4.1%.

The consensus among 18 of the 30 economists Bloomberg surveyed was that the central bank would raise rates by 25 basis points (bp), although market pricing suggested the RBA would leave the Cash Rate unchanged.

In the accompanying statement, the RBA said the rate pause will provide the central bank time to assess the impact of its tightening cycle.

Policymakers cited weakness in household consumption and dwelling investment as evidence to support keeping rates on hold.

And, although inflation is declining, it is still too high. Accordingly, the RBA kept its options open by stating further tightening may be necessary, depending on how inflation and the economy evolve.

Looking ahead, the market prices a slight possibility of one more 25bp rate rise, which should occur in Q1 2024.

The market currently sees the RBA staying on hold in September and October, pricing  5bp of tightening for the November meeting. It prices 6bp in December should the RBA stand pat the month before.

The RBNZ

The RBNZ met last week and left its policy rate (Official Cash Rate, or OCR) unchanged at 5.5%. This was the consensus analyst expectation, and in line with market pricing.

In the accompanying statement, the RBNZ said that ‘…the current level of interest rates is constraining spending and hence inflation pressure, as anticipated and required.’ The RBNZ added that ‘… the OCR needs to stay at restrictive levels for the foreseeable future….’

In an interview, RBNZ Governor Adrian Orr said New Zealand needs a mild recession to rein in the economy and return inflation to target.

Looking ahead, the market prices a ~50% probability of the RBNZ tightening rates by 25bps one more time before the OCR peaks.

Although the central bank is expected to keep rates unchanged at the 4 October meeting, markets price a 30% chance of a 25bp hike before yearend.

Beyond this, if the RBNZ does not hike once more in 2023, the probability of that final 25bp rate hike peaks at ~49% in February 2024.

The Norges Bank

The Norges Bank hiked 25bp to 4% last week, the 12^th rate increase since September 2021. Norges Bank Governor Ida Wolden Bache signalled a further rate rise in September, with additional tightening beyond next month contingent on incoming economic data.

The 25bp rate rise aligned with consensus expectations and follows weaker-than-expected July inflation readings.

The headline CPI print, both month-on-month (at 0.4% vs 0.9% expected) and year-on-year (5.4% vs 5.9% expected) came in below consensus, with both measures softer than the previous readings. Underlying inflation also softened year-on-year, from 7% to 6.4%.

With inflation falling and the currency off its recent ~four-year low seen in May, a consensus is growing that next month’s expected rate hike might mark the end of Norway’s tightening cycle.

The Riksbank

The Riksbank tightened policy on 29 June, hiking to 3.75%. At that time, elevated inflation was cited as a major concern for the central bank, as was SEK weakness.

Recent Riksbank messaging has underscored the central bank’s focus on (and worries about) inflation.

First Deputy Governor Anna Breman last week said that the Riksbank needs to be prepared for the risk that inflation could reaccelerate, citing factors including geopolitics. Breman also cited SEK weakness as a challenge, saying a weak krona ‘counteracts the decline in inflation.’

Market pricing is consistent with the June statement, when the Riksbank said it expects to increase the policy rate ‘at least one more time this year.’

Markets fully price a 25bp rate hike at the 21 September meeting, with a ~44% chance of a 50bp hike (i.e., ~36bp of tightening is currently priced for next month).

Our Favoured Antipodean and Scandi Trades Revisited

Last month, we wrote about our favoured trades in the Aussie, Kiwi, Norwegian, and Swedish FX and rates markets. They performed well, and we keep them into yearend.

Long Australia 2 Years

The most recent intra-day high in the Australia 2-year yield (using 2-year IRS vs 6-month bills) was 4.93%, which printed on 7 July. This was the day after we published our most recent piece on Aussie yields, calling for downside ahead. The yield now trades at 4.35%.

We remain bullish for the same reason as last month.

With the RBA’s tightening cycle almost over, upside for short-end Aussie yields will be limited. Inflation is softening, as are the PMI readings. Both manufacturing and services readings are below 50, implying contraction in both sectors.

Given the strong fall in the 2-year Aussie yield in the past 5-6 weeks, there may be room for a retracement higher. We would fade any such move, viewing any yield upturn as an opportunity to add to existing long exposure.

The trend for lower Aussie short-end yields is firmly in place. We expect more downside.

Long New Zealand 2 Years

The most recent intra-day high in the New Zealand 2-year yield (using 2-year IRS vs 6-month bills) was 5.77%, which also printed on 7 July.

The yield now trades at 5.53%, near the middle of the range for the past 5-6 weeks.

We expect lower Kiwi short-end yields for similar reasons as for our Aussie call. As with the RBA, the RBNZ’s tightening cycle ending, limiting the upside for Kiwi short-end yields. Inflation in New Zealand is also softening, with contractionary manufacturing and services PMI readings for two straight months.

Even with the upward retracement off the most recent low (at ~5.35%) on 18-19 July, we expect the 2-year Kiwi yield to trade materially lower.

Despite the recent bounce off those lows, the 2-year Kiwi yield is still 13bp lower than when we flagged the merits of going long.

As with Aussie short-end yields, we think the trend for lower Kiwi yields is firmly in place. We expect more downside.

Long NOK/SEK

Since we published our bullish NOK/SEK view on 6 July, the pair is trading 1.6% higher, moving from 1.0159 to 1.0317. In this period, NOK/SEK has traded as high as 1.0497 on an intraday basis.

Looking forward, we think NOK/SEK can trade back to 1.10, the high of this time last year.

The reason is simple. We think the Norwegian economy will outperform the Swedish economy, which will favour NOK over SEK.

The Norges Bank policy will probably at least keep pace with the Riksbank policy, so interest rate differentials will not shift materially in favour of SEK.

Moreover, with the highest readings in the G10, Sweden has a more acute inflation problem than its peers. While this argues for higher Swedish interest rates, it also undermines faith in the economy and the Riksbank’s management of it. We think higher inflation will drag on the Swedish economy.

This is negative for the currency and will therefore make a long NOK/SEK position more attractive.

Richard Jones is a Macro Strategist for VDK Capital, a London-based venture capital firm. He has traded and invested in interest rate and FX market portfolios spanning three decades, both on the buy-side and sell-side. 

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)