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US versus the rest of the world

The global central bank theme has really ramped up and continues to be the most significant theme of the year.

US
Source: Bloomberg

While the US ended its asset purchase programme last year and is gradually moving towards a tightening bias this year, the rest of the world is under pressure to ease. It hasn’t taken long at all and we are already seeing some aggressive action from key central banks. The central focus has been on preventing falling inflation, which has been predominately driven by a glut of savings and falling key commodities, with central banks having to use monetary policy to control prices.

With many economies having structural issues, there is real scepticism that the moves will do more than throw markets around; however central banks have to be seen as trying. This year we have already seen action by the European Central Bank (ECB) and other central banks in Canada, India, Scandinavia and Turkey. There has also been some market-moving action from the Swiss, New Zealand and Brazil. As a result, traders have had to be more alert than ever in order to stay ahead and position accordingly.

Action being taken by central banks has had the biggest influence in FX markets and will continue to influence how equity markets trade globally.

Europe engages in aggressive stimulus

The ECB has by far announced the largest and most decisive measures in 2015 after years of deliberation around an all-out quantitative easing (QE) programme. The €60 billion a month over 18 months programme will see the ECB expand its balance sheet by around €1.1 trillion. Essentially the ECB’s plan is to get its balance sheet to the same size seen back in 2011/2012. The result was a record high for the DAX and EUR/USD at its lowest level since September 2003.

Given the divergence between Europe and the US, shorting EUR/USD on strength is likely to be one of the most prominent trading strategies this year. We have also learnt recently not to fight central banks and this is just another example. Euro weakness has been coming for a while and it would have been detrimental not to follow the signs.

On the equities side, the DAX is likely to present opportunities for buyers on dips. With the ECB having deployed stimulus and the euro weakening significantly, it seems the DAX is in a very good position to benefit. Additionally, weaker commodities present the German economy with a net positive effect. Data out of Germany recently has also been showing signs of bottoming, suggesting the economy is on the recovery path. Financial institutions will also have access to cheaper funds and this is good for the economy.

Canada hit by oil

Oil has played a big role in influencing central banks this year, with the BoC and Bank of Russia being the most impacted. Canada cut rates as the oil price plunge threatens to see its trade deficit widen. This in turn is expected to weigh on jobs growth, wages and other key economic activity measures such as consumer spending and the housing market.

The BoC has already cut rates and is likely to be considering further easing should the turmoil in oil continue to put pressure on the economy as widely expected. As a result, the Canadian Dollar (CAD) is one currency to watch closely, particularly against the greenback as the two economies experience diverging fundamentals.

The CAD was one of the worst performing G-10 currencies in January, dropping 9%, and USD/CAD has been in a steep uptrend as a result. With a high correlation between oil prices and Canada’s economic backdrop, it is likely we’ll continue to see a similar trend should the turmoil in oil prices continue.  Essentially the BoC’s oil price assumption is $60/bbl and a period of oil prices below this level opens the possibility for further easing. Meanwhile, the Fed continues to move towards rates lift-off and this makes USD/CAD an enticing prospect for traders.  

RBA’s hand forced

In Australia, the swaps market had been pointing to a cut for a while and the RBA delivered on this at its February meeting. Interest rates in Australia were cut by 25 basis points to a record 2.25%. With growth continuing at a below-trend pace, domestic demand growth quite weak and unemployment moving higher, the RBA felt it necessary to cut rates. Output growth is expected to remain below trend and unemployment is likely to peak a little higher than the RBA earlier expected. All up, the statement perhaps didn’t sound as dovish as many would have wanted to reinforce the idea of another rate cut being on the way. The RBA will be looking to see if this can support demand and bring growth and inflation back towards target. It certainly doesn’t seem the RBA will be in a hurry to cut again but given the pressure from other global central banks acting, it seems this wouldn’t be completely out of reach. This puts AUD/USD firmly as one of the key trades to look out for this year. The preferred strategy among traders is likely to be selling strength in the pair given it has already lost significant ground.

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