There’s been some big moves in currency markets so far in 2017, especially against the US dollar.
It’s been smoked, propelling other major currencies such as the euro, British pound and the Australian, New Zealand and Canadian dollars sharply higher.
After such a pronounced move, it’s got many traders wondering what will happen next.
To Zach Pandl, co-head of global foreign exchange and emerging markets strategy at Goldman Sachs, now is not the time to position for further US dollar weakness, nor further euro gains.
Instead, in his opinion, investors should focus on the “favorable global growth backdrop and the relative cyclical position across markets”, noting that a number of central banks that have been cautious in years past “may be more comfortable talking about policy normalization” now that the global economy is on a more solid footing.
To take advantage of the likelihood that other central banks will join the US Fed and Bank of Canada in normalising policy settings, Pandl has offered three trade recommendations that he expects will outperform in the remainder of the year.
“We are initiating three ‘time to normalize’ trade recommendations,” says Pandl: long SEK and NOK vs EUR and GBP, long AUD and NZD vs JPY and short USD/CAD.
Here’s a few snippets from a research note he released on Wednesday explaining the basis for each trade.
To begin, while he likes the Scandies — the Swedish krona and Norweigen krone — against both the euro and UK pound:
The cyclical picture in Sweden and Norway differs slightly, but we think both the Riksbank and Norges Bank will begin normalization sooner than markets anticipate. In Sweden, inflation has moved above target, and inflation expectations have rebounded after sliding between 2012 and 2015. A policy rate of -0.5% no longer seems appropriate for this economy.
Norway is still dealing with some spare capacity, but growth is now booming. Norges Bank could therefore consider reversing its most recent rate cut, from March 2016, at some point next year.
On the funding side, we expect the ECB to hold policy rate expectations steady even as it moves ahead with QE tapering, and we believe the Bank of England will continue to look through above-target inflation due to political uncertainty and long-term risks posed by the Brexit process.
Next, why Pandl likes the Aussie and Kiwi dollars against the Japanese yen:
As in Sweden and Norway, domestic fundamentals differ somewhat in Australia and New Zealand. But while the specifics may differ, we expect both central banks to move policy rates up sooner than markets currently anticipate and both exchange rates to receive a tailwind from favorable global growth.
At the same time, monetary policy in Japan looks very unlikely to change for the time being, and yield curve control should amplify the effects of higher global rates on the Yen. If the global economy holds up, we think AUD/JPY and NZD/JPY likely offer significant upside.
And finally, why he expects the Canadian dollar will continue to rally against the US dollar:
We think markets may still be underestimating the potential for multiple hikes over the next year. Growth in Canada has been very solid: real GDP increased by 3.7% in Q1 and is on pace for a similar gain in Q2, and this spring the BoC shifted forward the point at which the output gap would close. Inflation is still below target, but policymakers appear more focused on diminished spare capacity and, to some degree at least, financial stability risks. With the unemployment rate falling to just 6.3% in July and house prices still very elevated, we doubt the BoC will be inclined to pause any time soon. As a result, we think USD/CAD can head lower again after retreating over the last few weeks.
Pandl says that all three trades are pro-cyclical, fitting with the strength in the global economy at present.
However, as with many trade recommendations, it has caveats attached.
“A stumble in global growth or geopolitical tensions — in the Korean Peninsula or elsewhere — could adversely affect our recommendations,” Pandl says. “They are also long commodity-oriented currencies, and a significant drop in crude or base metals could result in underperformance.”