G10 FX Weekly: More Favoured H2 2023 Trades After Central Bank Deluge

Summary

• Central banks have been very busy over the past month, with several rate moves enacted and important messaging communicated to markets.
• This week, we focus on Australia, New Zealand, Norway, and Sweden. As with the other G10 central banks we looked at last week, Antipodean and Scandinavian central banks have completed the bulk of their respective tightening cycles.
• This presents market opportunities for H2 2023.

Market Implications

• Following last week’s piece, we have three additional favoured trades for the coming months, focussing on the Antipodean and Scandinavian markets.
• Receive 2-year Australia rates – elevated Australian yields, as the Reserve Bank of Australia (RBA) approaches the end of its hiking cycle, look attractive. We look to fade any yield upside in the 2-year tenor with a view to scaling-in to a long rates position, anticipating material downside in the yield towards year-end.
• Receive 2-year New Zealand rates – the same argument in the Australian rates market applies for New Zealand, although, with market pricing pointing to the end of the Reserve Bank of New Zealand (RBNZ)’s tightening cycle, we find this trade even more attractive.
• Bullish NOK/SEK – we expect the Norwegian economy to outperform the Swedish economy, and for interest rate differentials to favour the Norwegian Krone (NOK) over the Swedish Krona (SEK). We therefore like a long NOK/SEK position, with the pair to trade back to the top of its 1-year range in the coming months.

Introduction

There has been a flurry of central bank rate decisions over the past month, with several authorities tightening monetary policy in recent weeks.

Last week, we looked at the G10 central bank landscape, examining the policy stances of the US Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, the Swiss National Bank, and the Bank of Canada. We advocated three favoured trades based on the current and expected policies of these monetary policy makers.

This week, we look at the RBA, the RBNZ, Sweden’s Riksbank and Norway’s Norges Bank, and highlight three favoured trades based on the current and expected policies of these central banks.

In the Antipodean and Scandinavian markets, the standout trades in the FX and rates space include receiving 2-year Overnight Index Swaps (OIS) in Australia and New Zealand, in anticipation of short-end yields going lower in those markets.  

We are also biased for NOK to outperform SEK. We think the Norwegian economy will outperform the Swedish economy, and interest rate differentials will favour NOK in the coming months.

G10 Central Bank Landscape (Part 2)

Reserve Bank of Australia (RBA)

The RBA kept its policy rate unchanged at 4.1% at its most recent meeting two days ago. Going into the meeting, there was a ~20% probability of a 25bp hike this week.

In its statement, the RBA said that ‘some further tightening of monetary policy may be required,’ and that the central bank will be data dependent. In keeping rates on hold, our view is that the RBA chose to focus on growth concerns rather than inflation persistence – their focus could likely reverse following the Q2 CPI print (26 July).

Looking at inflation, year-on-year (YoY) headline CPI fell sharply, to +5.6% YoY from +6.8% YoY, a much bigger drop than expected. This was enough to see the RBA emphasise concerns over risks to domestic household consumption rather than inflation, and keep rates on hold. However, this required them to ignore stickiness in underlying and services inflation.

The market prices another 25bp rate hike, currently expected in September, with a ~45% probability of this occurring next month. After September, there is another ~15bp of tightening priced this year.

Reserve Bank of New Zealand (RBNZ)

The RBNZ hiked rates by 25bp at its most recent meeting on 24 May, with the New Zealand’s Official Cash Rate now at 5.5%. This is the highest nominal policy rate among G10 central banks.

After acting aggressively and proactively to raise rates since 2021, from a low of 0.25% to the present level, the latest rate hike was dovish. We think this is probably the last hike of the current cycle.

Market pricing is also consistent with this view, with a less than 10% probability of a rate hike at next week’s RBNZ meeting. Market pricing suggests that the RBNZ will now hold rates at the current level at least until Q2 next year.

The New Zealand economy is now in recession. Last month, data showed that New Zealand’s GDP contracted 0.1% in Q1, following a 0.7% contraction in Q4 last year.

Norges Bank

Norway’s Norges Bank hiked rates by 50bp at its most recent meeting on 22 June, raising its policy rate to 3.75%.

This was the eleventh hike since the current tightening cycle began in September 2021.

The 50bp move, enacted to combat inflation and lift Norway’s weak currency, was more aggressive than the consensus expectation of a 25bp hike.

Moreover, the Norges Bank’s policy forecast had a more hawkish tone, with rates ‘most likely [to] be raised further in August,’ and the policy rate to peak at 4.25%, or 50bps higher than the current rate.

Riksbank

Sweden’s Riksbank raised rates by 25bp to 3.75% on 29 June, citing elevated inflation, exacerbated by a weaker SEK, as the basis for the decision.

In the statement accompanying the decision, the central bank stated that it expects to tighten policy further, with the policy rate to be increased ‘at least one more time this year.’

The Riksbank also decided to continue with its quantitative tightening measures, increasing the pace of bond sales from SEK3.5bn to SEK5bn, beginning in September.

Market pricing currently assigns a ~40% probability of a 25bp rate hike in September.

Three (More) Favoured Trades for H2 2023

Given the landscape for the Antipodean and Scandinavian central banks, we favour three trades for H2 2023: Lower 2-year yields in Australia and New Zealand, and long NOK/SEK.

Receive 2-Year Australia OIS

The 2-year Australian yield (using OIS) is currently trading at a multi-year peak at ~4.48%, with the 2023 range ~3.14%/~4.48%.

With most of the RBA’s tightening cycle completed, we think that scaling-in to a received 2-year OIS position, in anticipation of lower yields in the coming months, is compelling.

With additional hiking priced into the Australian curve, in addition to the RBA itself hinting at further tightening, we advocate a patient approach to building this position.

Rather than go all-in at current levels, we think it is prudent to initiate modest exposure over the coming months, leaving the possibility of adding to the position on any grind higher in the 2-year yield.

Rates in Australia may not have peaked, but we think they are close to doing so. Building a long rates position in the Australian short end, therefore, appeals to us.

Receive 2-Year New Zealand OIS

The argument in favour of building a long 2-year New Zealand rates position is very similar to what we advocate above in the Australian rates market, although the trade is even more compelling in NZD.

The 2-year New Zealand yield is currently trading at its 2023 peak at ~5.49%, with the YTD range being ~4.47%/5.49%.

While, as in Australia, there is a chance that the RBNZ could raise rates again, it looks very unlikely. The market prices a minimal probability of further tightening, and the RBNZ itself hinted that the rate hiking cycle is complete. This is what makes the trade even more compelling in the New Zealand short end.

With New Zealand in recession, it is easy to make the case that the cycle has ended. It is also reasonable to expect that the next move will probably be a rate cut.

Still, as in Australia, we advocate a patient, scaled-in approach to building a long New Zealand rates position. Rates are close to peaking, if they have not already.

Initiating modest exposure at current levels makes sense, leaving room to add to the position on any grind higher in yields.

Bullish NOK/SEK

Since the beginning of last year, NOK/SEK has traded in a ~0.95/1.10 range, that has defined the pair for most of the past decade.

NOK/SEK traded at the upper end of the range in March and August last year and printed the low at ~0.95 in early May. Since then, the pair has had a run higher of about 7%.

Looking forward, we think that the Norwegian economy will outperform the Swedish economy, and that the Norges Bank will be more aggressive than the Riksbank in tightening monetary policy.

This will shift interest rate differentials in favour of NOK.

In recent weeks, the pair consolidated its gains from the low in May. This week, the pair has traded above 1.02 (currently ~1.0260), which now opens further upside in the pair. Our view is that we should see NOK/SEK trade back to the top of the range at 1.10 in the coming months.

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. 

Ben Ford is Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

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.)