To The Moon

Views are my own. Not investment advice. Just my thoughts on Macro developments.

Powell:

“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,”

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

“We will continue to make our decisions meeting by meeting,” Mr. Powell said. “Although inflation has been moderating in recent months, the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy.”

The market was caught sleeping as most were waiting for NFP and BOJ on Friday for FX price action. Although I have been expecting an increasingly hawkish Fed I was surprised to see Powell use the Senate Banking Committee testimony as a platform to pivot on his previous comments. It is clear that Powell is already regretting his previous comments about the US being in a “disinflationary process”. The “disinflationary process” line will probably go down a bit like the “transitory inflation” line did last year as he is forced to pivot again so quickly. The market is now pricing over 40bps for the March meeting. From here a lot will depend on the NFP on Friday. There has been a lot of talk of seasonal adjustments driving the recent strong data out of the US so there is expectations of strong revisions to the Jan number and a weaker Feb number. If that proves true then some of this USD strength could quickly reverse. Personally I feel the seasonal adjustment claims are overdone. The US data has been so consistently strong and I feel that this is a result of the sharp easing in financial conditions that the Fed allowed between November and February. The Fed allowed inflationary pressures to reignite and now it will need to cause more pain to markets to get them back under control.

AUD looks particularly vulnerable right now. In stark contrast to Powell, RBA’s Lowe was discussing a pause to their hiking cycle overnight. Lowe said “We also discussed that, with monetary policy now in restrictive territory, we are closer to the point where it will be appropriate to pause interest rate increases to allow more time to assess the state of the economy.”

With RBA looking to join the BOC in pausing to assess rate hikes it leaves these growth currencies particularly vulnerable as rate divergence is now fighting against them just as global growth also looks fragile. I am staying short AUDUSD and NZDUSD as I expect the market to prefer to own a safe haven like USD where you get a yield pick up and protection against a larger risk off move all in one. AUDUSD has come a long way in a short time but I do not think the market is short as the market was still long AUDUSD on the China reopening trade until this week.

The market is still long risk currencies in general. As vol has trended lower this year most have been searching for yield in EM. This was helped by the energy crisis in Europe easing which made the likes of PLN and HUF great carry opportunities and the China reopening trade which enticed the market into AUD, KRW, CNH and MXN. I expect that short USDEM is still a large position. I see increasing risks to these trades not just from the Fed but also from any escalation in Ukraine or between US and China. I have spoken before about how I see an increasing risk that Russia escalates the war as they are now backed into a corner with the US debating sending F16 fighter jets along with the tanks that are already on their way. This could come from pulling Belarus into the conflict. Also I am increasingly concerned about the US orchestrating a round of sanctions on China. FMR US Defense Secretary Mark Esper spoke to Bloomberg and said that the US would bring together their allies to place sanctions on China if they were providing lethal aid to Russia. Mark Esper argued that in the modern world even something like Micro Chips can be considered lethal. He also thinks it is inevitable that Ukraine will be provided with F16's eventually. It all seems to point to escalation and any coordinated sanctions against China would be catastrophic for AUD and EUR. Something worth having on the radar

I am still long USDJPY and that is my strongest view. The market if anything is still short USDJPY, although I suspect mostly via options. RR’s have been skewed aggressively to the downside for some time as the market does not want to miss out on the possibility of a hawkish shift from the last dovish central bank in G10. I still see value in topside options as USDJPY can be equally aggressive to the topside in a hawkish Fed environment as we saw last year. I feel that the market is still too soon to be calling for a hawkish shift from the BOJ. Real wage growth in Japan is still negative. The recent rise in wages was mostly driven by one of bonuses rather than persistent pay increases. This is why Kuroda and Ueda have been sceptical about the persistence of inflation in Japan. They have been trying to achieve inflation for 20years, I expect that they will wait to see the whites of inflations eyes before adjusting policy. Although I do agree that there is a risk of another adjustment to the YCC band. The disfunction in the JGB market has only increased since the last adjustment so Kuroda may feel that they need to do more. Any dip in USDJPY on a widening of the YCC band would prove a buying opportunity as it did last time.