Westpac bank's trading model confirms we should be wary of higher-yielding currencies such as CAD and NZD while suggesting smart money should be increasing holdings of safe-haven gold.
Australian lender Westpac are forecasting that the Australian Dollar and the New Zealand dollar will suffer further downside in the week ahead whilst the yen, franc and euro are set to gain.
“The G10 FX model adopts a decidedly risk averse posture for the week ahead, opening short positions in AUD and NZD, while on the other side of the ledger the model opens long positions in CHF and JPY.”
Short positions are those in which a trader bets the currency will weaken and therfore sells it, whilst long are those in which he bets the currency will strengthen, and therefore buys it.
The change in forecast for the Aussie came as a result of Australian inflation data, which showed a sharp drop to 1.3% from 1.7% expected, and then the actions of the Reserve Bank of Australia (RBA), who reduced interest rates from 2.00% to 1.75% at their May 3 meeting.
Westpac are also bearish the New Zealand Dollar:
“Enthusiasm for NZD has proven to be short-lived, the model flipping from a 16% long to a 6.4% short for the week ahead. Weaker commodity prices are the main catalyst, via our short term macro momentum signal - logit probability. “
The model also doubles the size of its Canadian dollar short position to -16.1% of the portfolio for the week ahead.
“Lower CAD yields vs the majors and a weaker logit probability macro signal as the run-up in crude oil crests are the main catalysts.”
The portfolio retains its large 20% long position in euros as a result of the regions continued rising current account surplus, which shows higher net demand for the regions exports, and therefore its currency.
The model is also, however, reacting to a new “positive growth signal” and improved outlook for yields in the eurozone:
“The region’s huge current account surplus has been an important catalyst for the model’s structural EUR long but interestingly we are now also observing a positive growth signal and a less weak total yield signal too.”
Given its strong bias towards seeing a fall in risk appetite, it is no surprise Westpac’s forecast favours the safe-haven currencies of the yen and the Swissie - as well as the ultimate safety play Gold.
“The model flips from JPY shorts to a 9.2% JPY long as JGB’s underperform other major markets. The model also wants to be long CHF for the week ahead, a rarity for the model which has consistently favoured CHF shorts. For the week ahead the model has 8.3% CHF long, the most constructive the model has been on CHF in 17 months. A stronger Swiss growth signal after last week’s much firmer than expected PMI data and higher Swiss fixed income yields vs much of the G10 are the main catalysts.”
The model is bearish and short the pound, with -12.9% of the portfolio holding allocation.
In his accompany commentary, Westpac’s FX Strategist Richard Franulovich says that risk aversion is more apparent in emerging markets than G10:
“The stain of risk aversion is very apparent in emerging market equities, metals and bulk commodities and currency markets, while developed market equities, credit markets, energy markets and the VIX and Move indices have been on a more stable footing. The risk going forward is that risk aversion becomes more pernicious. Why?”
He argues, however, that negative sentiment could ‘spread’ beyond EM and become more “pernicious” due to the strong possibility that US Q2 growth may be disappointing, which would be a very negative sign for the US after the poor Q1 growth.
At the moment it is still considered possible the Q1 result was an anomaly, since the first quarter can often show reduced growth, often due to bad weather. Analysts are less sure that is a valid reason this Q1 as the weather was not so poor, nevertheless, they have not yet discounted the possibility it could hve been a seasonal ‘blip’ rather than the start of a down-trend.
He also suggests Chinese growth may be stalling again:
“Worryingly, China’s recovery – while unsustainable all along given broader deleveraging pressures – appears to have stalled after barely a month, certainly that’s the impression left by the softer April PMIs and weaker April import data. Past stimulus cycles going back to 2008 produced a recovery in the PMIs that typically lasted 4-5 months.”
Data towards the end of this week could be telling as they will reveal more signs as to whether Q2 is likely to be as bad as early indicators suggest:
“Data due later this week - US April retail sales due Friday and China April industrial production due Saturday - could be highly informative and very consequential for global markets.”
Franulovich further points out the fact that a weak Q2 for the US and further slowdown in China would have a very negative knock-on effect on Fed rate hike expectations, which would no-doubt be delayed even later than the current market expects. This in turn would weaken the dollar.
Uber safe-haven Gold saw a massive and sudden 30% boost (from 210k to 270k) in long futures positions according to Commitment of Traders (COT) report from US futures exchanges released on Friday May 6.
This shows hoarding by large speculators, hedge funds and ‘smart money’ who appear to be positioning for a rally in the precious metal. This is almost always due to a crisis and reduced risk-taking.
Westpac’s negative Australian Dollar position in their G10 model portfolio is also supported by the COT data for Australian Dollar futures contracts, which shows a negative pivot in long contracts, after they fell in the previous week from the peak two weeks ago.
These ‘pivots’ tend to augur a corresponding fall in the AUD/USD pair in the week ahead, with a roughly 60% accuracy. They are hardly ever correlated to a substantial strengthening in currency, even when they are wrong.