Weekly Investment View: Exit Short TWD, Plus Contrarian Trade Idea

This Week 

Bilal discusses the contrarian trade of the quarter; Dominique previews PMIs and NFP; John notes growth equities shining as rates rise; Caroline sees another (smaller) pre-election rate cut in Poland; Mirza exits our short TWD position; Henry thinks long BTP trades could soon look attractive; Ben expects a hawkish pause at the RBNZ meeting; Viresh anticipates a tactical pullback in oil. 

Bilal Hafeez – Global Macro 

FX carry has been an impressive strategy in 2023. Our classic carry is up 19% this year!   

But something has started to shift. If we look at the correlation of recent FX performance and the level of yields, we find G10 remains correlated with the level of yield (carry), but EM has stopped being correlated (Chart 1). 

Drilling down within G10, most currencies are where they should be. The outliers appear to be JPY (should be weaker) and GBP (should be stronger). This would suggest a long GBP/JPY trade. It is not in line with our view but could be the contrarian trade of the quarter!  

Dominique Dwor-Frecaut – US Macro 

This week I focus on PMIs and NFP. The August small business optimism survey showed a pickup in activity since end-2022. I expect both the services and manufacturing PMIs to confirm this by surprising on the upside. 

For NFP, I will focus on wage growth. Headline inflation is rising due to rising oil prices.  Accelerating wage growth is a key channel through which higher energy prices could lead to generalized price pressures. In addition, wages need to keep up with inflation for consumer demand to remain strong. This is especially important as all the labour idled by the pandemic has been brought back into the labour force, and employment growth is converging to the growth in labour supply (Chart 2). 

John Tierney – US Equities 

Rising rates triggered the September equity selloff, but our base case remains that the Fed will err on the side of wait-and-see rather than keep pushing its policy rate higher. 

The growth sector (RPG) was the stronger performer in September, contradicting the popular narrative that higher rates are weighing on growth more than value. That is another reason to remain constructive on equities (Chart 3). The equally weighted SPX (SPW) was the worst performer, implying larger companies outperformed smaller companies. 

Q3 earnings are projected to be up 2% quarter over quarter for the S&P 500, and an impressive 10% for the NASDAQ 100 – perhaps a source of support for growth. This is a departure from recent quarters when quarterly projections were flat or below the previous quarter.  

Companies have posted impressive beats so far in 2023; that may be less the case for Q3 earnings. Only seven companies report this week, with attention on the consumer staples sector and what people are eating and drinking. 

Caroline Grady – Emerging Markets 

September CPI below NBP expectations at 8.2% YoY (from 10.1% in August) should be sufficient ammunition for another pre-election rate cut in Poland. While only partial details are available, the -0.4% MoM decline looks fairly broad-based, albeit helped by the probably state-directed decline in fuel prices.  

PLN has stabilized after last month’s surprisingly large rate cut, and the domestic data remain weak. Updated forecasts will be available only at the next meeting in November but, rather than waiting for the projections, we expect Governor Glapinski will reiterate that forecasts will be lowered. Concrete guidance on how the easing cycle will proceed from here is unlikely. While we expect Glapinski to remain in office regardless of who wins the 15 October election, the zloty dynamics post election will impact the timing of further rate cuts. 

Mirza Baig – Emerging Markets 

We are closing our long USDTWD position at 32.32, initially entered on 21 September at 32.12 (1m NDF). While the trade has moved our way, the currency’s reaction to higher US bond yields and sell-off in mega cap tech is relatively muted.  

Diminishing returns to negative catalysts implies the market is already quite long USD, which is further evident from a near record gap between onshore forwards and NDFs. As such, we exit this trade for now.

Henry Occleston – Eurozone & UK Macro 

Last week saw EZ headline and core inflation surprise to the downside. We had seen upside risks from the degree of repricing typical in September but, if anything, this seems to have counted against it. At +4.5% YoY, core inflation is undershooting the ECB’s expectations for Q3 – starkly contrasting our expectations. 

While understanding further information on the exact composition of the core inflation decline will be important, the outcome for now seems very dovish.  

Policymaker comments will probably be the most important thing to watch in this context, as there will be a lot of speakers on the wires this week. 

We expect the dovish tone can keep building in both the UK and Europe, with the ‘persistence’ argument for holding rates stable continuing to gain traction.  

In markets, our last Global Rates Weekly flagged that long BTP trades could end up being profitable at these levels. Italian troubles are never far from the headlines, and the announcement that Italy’s 2024 fiscal deficit would likely overshoot initial assumptions provided a headwind. However, the levels are looking more attractive. 10Y BTP is now at 185bp spread over 10Y Bund, near the highs seen in May, while outright it is near decade highs. We are watching the levels closely for an opportunity to enter. 

Ben Ford – $-Bloc & Scandies 

The October meeting should see another Reserve Bank of New Zealand (RBNZ) pause. However, much like in August, we expect a hawkish pause. Hawkishness is likely to come through their forward guidance: raising the policy rate forecast and moving the timing of the first cut. This would prove in line with the NZIER Shadow Board who have now shifted to expecting a longer peak. 

The risk stems from several origins, pointing to stickier non-tradables inflation. First, GDP (+0.9% QoQ) was far stronger than expected (+0.5% QoQ), which was buoyed by unexpected resilience in household consumption (+0.4% QoQ vs forecasted: -1.8% QoQ). Second, weakness in labour market surveys is yet to pass through to official data. This matters as the RBNZ concentrates on a suite of indicators that have paused in recent data releases (Chart 7). Third, the RBNZ are unsure of how drastic a passthrough we will see in Q4 2023/Q1 2024 of the mortgage rollover. As a result, they want to keep hawkish optionality on their side, something they failed to do last year when the OCR was at 4%. 

Viresh Kanabar – Commodities 

The oil market remains tight. However, this is not new information. Implied tightness can be observed through backwardated prompt spreads. For both Brent and WTI (M2M1), prompt spreads are almost the most inverted they have been outside Russia’s invasion of Ukraine at c. $1.80.  

Last week, prompt spreads blew out to over $2.0, but have since retreated. Relatedly, front-month Brent also fell back below $93 – in line with our view. 

The collapse in crack spreads – particularly in gasoline – stood out to us last week. We know refiners begin to switch to a winter blend in gasoline around this time of the year. Meanwhile, the driving season is over. Winter blends tend to be a higher vapor blend to cope with the lower temperatures. Gasoline inventories, particularly in the US have also recovered to around 220mn barrels, edging nearer the five-year average. It is currently not obvious which of these factors (or even a combination) have driven the almost $5.5 decrease in the RBOB-WTI spread in each of the last two weeks. 

Low crack spreads – as shown by the 3-2-1 crack spread – have two slightly offsetting effects: 

1. They help reduce the passthrough of higher oil prices for consumers – which in turn can help sustain demand. I.e., gasoline prices go up by less than the oil price. 

2. They reduce the incentive for refiners to run at high utilisation rates, reducing refinery throughput. 

Point 2 is important given the shortage in diesel stocks – we continue watching closely.  

We remain neutral on oil at this stage. Tactically, we think there could be a pullback to around $87.50.  

(The commentary contained in the above article does not constitute an offer, 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.)