Trader Notes: Will The Fed Pivot and How to Position for It?

NZD might outperform

From the list of currencies that declined the most this year, most have reasons to be there though NZD seem to stand out given that their rate hike cycle (current 3.5%) is well ahead of the rest (including the US) and terminal rate is currently above 5% expected some time next year. In addition, recent QoQ CPI data for Q3 came in hot at 2.2% vs 1.6% expected. These factors do not seem to warrant a decline of 15.4% this year relative to the USD and hints that if the Fed were to pivot, NZD could have a decent sized bounce. One possible risk to note is that the NZ current account deficit is quite negative at -7.7% of GDP as compared to the other currencies due to higher prices of machinery/vehicle/energy imports and a lack of tourism spending though these are expected to improve once supply shortages subsides and tourists return in full swing.

How About the Other Large Decliners?

JPY has good reason to be there given the BOJ’s dovish policy and commitment to yield curve control. Given that this has moved the most, any slight change in BOJ’s stance could trigger a large move in the opposite direction. However, barring that change, JPY would still be tough to hold given the huge carry cost and BOJ’s unlimited bond buying spree.

UK is going through one of the toughest times in history due to political and economic turmoil. Therefore, it is not surprising to see GBP fall 14.9% this year as the government struggles to balance growth and inflation. UK has just seen their third prime minister in 3 months and even though there has been the recent reversal of the infamous unfunded tax cuts, the current prime minister Rishi Sunak still has a lot of tidying up to do to regain growth.

Sweden Krona (SEK) has declined this year as Riksbank was known as one of the most dovish central banks before they started hiking more aggressively in September from 0.75% to 1.75%. Even then, these moves seem to be in response to the aggressive tightening central banks to prevent outflows.  Sweden is also not spared from the energy crisis in Europe with 30% of its LNG imports were from Russia before the war, and thus higher rates will not resolve inflation resulting from higher gas prices (which are more supply driven).

The Chinese Yuan (CNH) has also declined quite rapidly in the recent month, reaching new lows against the USD this week as the PBOC is back on an easing cycle to support the property market. There are also concerns that the recent consolidation of power by Xi would stifle business opportunities in the country and impede growth. In addition, with the government keen to support common prosperity this year because of the zero-covid policy, the PBOC is likely going to maintain an easing bias.

Conclusion

In conclusion, NZDUSD seems to have the best risk-reward skew as it has the highest policy rate among G10 currencies with scope to hike further on the back of still firm inflation data and market positioning given huge declines this year, with the key risk being the current account deficit. JPY might be an attractive one to look at if BOJ tweaks yield curve control with short positioning at very high levels and recent gains due to intervention might put pressure on shorts. GBP is in a grey area as we see how the new prime minister will navigate not just the tough economic environment but to push his agenda within his own government being young and less experienced. With a new leadership in place and a government keen on supporting the economy, CNH would be quite an unlikely candidate to go long until the economy stabilizes and PBOC changes their easing stance. Finally, even though inflation is creeping higher in Sweden, Riksbank has historically been more of a follower in terms of hiking rates than a leader, and the Fed pivoting might reduce their need for staying hawkish with an energy crisis to handle.