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FxWirePro: Take a glance at defensive and high beta currencies amid trade tensions
One should think that after the excitement of the past few days we might get a bit of a breather on the FX market. But the US President does not tire of criticizing the Fed and to top it off his tone seems to be getting more and more serious. Suddenly he says “our problem is not China“ but the country’s own central bank that refuses steadfastly to follow his advice. The President twitters it should "cut rates bigger and faster", the whole thing rounded off with more or less direct accusations of incompetence against the Fed.
Within FX markets, the dollar has broadly strengthened with the larger moves coming from EM, but the star outperformers have really been JPY and CHF.
The recommendation of a trading strategy has been defensive in recent weeks motivated by soft global growth dynamics and brewing trade tensions. The global economy was soft to begin with. In the weeks prior to the tariff tweets, we had been pointing to various growth momentum metrics that were leaning defensive — our EASIs were negative for 2/3rds of the countries we cover and our growth framework based on economists growth forecast revisions had increasingly been suggesting raising defensive exposure via USD longs (refer 1st chart). The prospect of additional tariffs should be reasonably expected to further worsen the backdrop. Recent experience shows that even though the mechanical impact of tariffs on growth may not be that large, impact via sentiment channels can have an outsized impact on markets. Recent developments thus not only reinforce our defensive approach to FX markets but warrant increasing it. We are focused on the following themes.
First, defensive currencies such as CHF, JPY, and USD are likely to continue to outperform. Historically, these have been the consistent outperformers in the late stages of expansions. More tactically, our recommended longs have primarily been focused on JPY and CHF rather than USD given that the Fed monetary policy was in play. Fed cuts are still in play Powell’s given escalation of trade tensions, but nonetheless, recent events have opened up room for USD outperformance versus high beta FX, alongside JPY and CHF. New tariffs are likely to elicit further dollar strength as China looks to offset the impact via policy easing which among other tools, is likely to include CNY weakening. The Asia strategists have raised their year-end target for USDCNY to 7.10 from 6.80 for instance. That these developments come in a month in which trading volumes are 25% lower than usual is likely to exacerbate effects. August also tends to be a seasonally supportive month for USD, CHF, and JPY at the expense of high beta FX, with the broad dollar index (JBDNUSD) specifically strengthening in eight out of the last ten years (refer 2nd chart).
Second, high beta currencies continue to look vulnerable given the macro and tactical backdrop discussed above; we recommend increasing defensive exposure via a new NZD short and unwind of NOK longs. The approach has to be the focus on the growth challenged currencies where central banks are likely to ease — AUD and NZD are the prime candidates to short and are fully reflected in our trade recommendations. We continue to look for further weakness in these currencies and in particular, increase exposure to NZD shorts (vs. USD) given the upcoming RBNZ meeting and the deterioration in the global backdrop. While these currencies have already been in play, positioning is still not at an extreme (refer 3rd chart) and further weakness still can't be ruled out given China linkages. Courtesy: JPM