Trade Idea: Buy AUD-CAD

Hey All, 

Apologies for my recent quietness, but I have exams through January so naturally they're taking a priority... don't get me wrong, I'm as active in markets as ever just haven't quite had the time to write down any thoughts. 

Anyway, here's my trade idea for the next couple of weeks - Buy AUDCAD with a target of 0.925 and a SL at 0.896 (Current 0.907). 

Starting with some technicals. AUDCAD has been int his downtrend for a while and we can see we are close to the typical lows of the trend. There is definitely room for a bounce. Likewise, we are pretty close to the 50d SMA so a move above this could be a catalyst for further upside. Finally, we are seeing an increase in the lows of the RSI, so maybe time for a bit of a reversal. 

Looking at the specific USDCAD market though, this definitely looks oversold! 

Source: FxPro MT5

Don't get me wrong, I still like USD short positions, which is the reason why I'd play this on the crosses instead. 

The CAD has moved a long way higher but the AUD hasn't really moved commensurately - which seems a bit odd when we look at 2y government bond differentials below where we see a very sharp and sudden convergence in the last few days. 

CENTRAL BANKS: 

The RBA: 

OK, so the RBA is still one of the more dovish central banks as inflation in Australia hasn't been quite as persistent as what we have seen elsewhere with a prior reading at 3%. Consequently, pricing for AUD rate hikes isn't as severe as elsewhere. 

1y IRS is priced at 48bps, and the RBA is at 10bps now, so this would imply a couple of hikes a year from now - this is rich compared to what the RBA is pricing for, but I wouldn't be surprised to see a quick end to QE at the next meeting in February and a slight shift to a more hawkish narrative - despite surging Covid cases in Australia. 

The BoC - The Crux of the Matter! 

This really is why I'm putting this trade on now - we have the BoC meeting on 26 Jan (3pm UKT) and this will be very interesting. The market is pricing in a hike at 80% probability! I have been very vocal in pushing back against this notion, and for me the balance of risks is definitely to the downside for the CAD. Unwinding an 80% probability of a hike if they don't hike should be pretty significant for the currency, and AUDCAD will likely move considerably higher. 

More than this, the expectation is for around 150bps of BoC hikes this year!!!!!!! Really? Do we believe this? Is the BoC really going to outpace the Fed by around 50bps. I suspect not... rather I would expect a gradual hiking cycle where response functions are analysed carefully to avoid spooking markets too greatly. 

The key from the meeting will be the guidance - if the BoC does hike, but says from now on we go quarterly then this will disappoint the market. 

Thus, it seems highly unlikely to me that the BoC will meet the markets expectations for hawkishness in January. I don't expect them to be fully clear on the hiking timeline, and this will disappoint the market - expect more clarity in the March meeting. 

https://www.bloomberg.com/news/articles/2022-01-13/traders-face-risks-with-bets-that-boc-will-outdo-fed-on-hikes?sref=DpmagNCl

The above article could be an interesting read for those who expect BoC hikes and hawkishness. 

SUMMARY: 

I see two key catalysts in the next month. 1) The BoC is likely to disappoint market expectations for extreme hawkishness. 2) The RBA risk is to a more hawkish stance - particularity if they are no longer worried about COVID given Omicron appears less dangerous. 

Thus, the trade for me is to get long AUDCAD - that way you keep the pesky USD out of the equation as well. 

Please do reach out with questions. 

Time to Shine? The 2022 Gold View

It won't come as any surprise to my frequent readers that I am heavily bullish on gold and the other precious metals. To me, the allure of precious metals at these prices is immense, and the only real direction I can see for precious metals over the course of 2022 is higher. 

Where are we now? 

Firstly, I've got two charts here outlining gold performance since the onset of the pandemic. The first is the outright gold price, and the second is the gold/silver ratio. While this piece focuses on gold, that does not mean I've forgotten about silver, and I am also bullish on this other commodity which has more of a pro cyclicality than gold. 

Above, the gold price in USD/oz shows how we are a long way off the highs of the pandemic which were set around USD2100/oz in mid 2020. Now, we are around USD300/oz lower - or around 15%. This has occurred despite the Fed and other central banks maintaining an unprecedented level of monetary stimulus over the last 2 years. 

Below, we also have another interesting chart - the gold/silver ratio. This chart I like as it shows the relative prices of the two commodities. As the chart below shows, we have clearly been in an uptrend over 2021, but this is not particularly concerning that we are actually lower than where we were prior to the pandemic. 

What about interest rate hikes and a tightening cycle? 

To me, this makes some degree of sense, given we are entering a major pro cyclical period where growth is outperforming and industrial metals are likely to perform well. However, going forward as the central banks of the world start to take their foot, of the monetary accelerator, I expect we could see a gradual increase in the gold/silver ratio once again similar to that in the last tightening cycle. 

If we take a look at the performance of gold/silver compared to the Fed's balance sheet we can see that it has traditionally risen during the periods of quantitative tightening. 

From Bullard's comments yesterday, it seems like balance sheet runoff is more than just something he is considering and an active aim of the Federal Reserve to reduce the size of the balance sheet before the next crisis. 

“Asset purchases will come to an end in the months ahead, but the FOMC could also elect to allow passive balance-sheet runoff in order to reduce monetary accommodation at an appropriate pace,”

In the previous period of balance sheet runoff, the above chart shows a gradual grind higher in the gold/silver ratio. Obviously, we only have a sample size of 1 here, and there were likely a number of other drivers behind the change in ratio to do with geopolitical risks, the broader economy etc. 

However, when we look at silver we can see that it has actually had a pretty decent run and is well above pre-pandemic levels. Much of the industrial outlook is probably already baked into the price, and from here while I like silver, and do not expect downside, I prefer gold due to its purer interest rate plays. 

The problem with rates: 

Let's now have a look at market pricing for Fed hikes. This really is where my conviction for gold comes from. There are essentially too possibilities this year. 

1) Inflation starts to cool down and the Fed is able to stick more with its longer-term objective of full employment within the economy. I.e. They do not hike as much as expected. 

2) The Fed panics about inflation and starts hiking too quickly, leading to a killing off of the global economy, which in turn requires more Fed support. I.e. They hike too quickly and kill the recovery. 

In either of these situations, the outlook for gold is pretty solid. The Fed is trying to engineer a situation where they perfectly judge everything and don't disrupt markets while keeping easy financial conditions. At the moment, everything is priced for a Goldilocks Fed hiking cycle. 

I needn't elaborate when I say history isn't exactly full of perfect Fed tightening cycles - nearly always we end up either with the economy running too hot or too cold and in recession. 

Source: Refinitiv - nearly 100bps priced for 2022!

To me, this is clearly showing that the risk is for the Fed to disappoint the market. In turn, this means that the outlook should be pretty weak for the USD, which in turn will be good for gold. If inflation does start to show signs of easing, then we clearly are in a position where the Fed will exercise patience. 

I have outlined lots of my views on the Fed repeatedly, and I don't want to repeat them all in the gory details here, but I am keen to stress the risk is clearly to the downside in this Fed hiking cycle. 

Personally, I don't see the first hike until June of this year. All of this should be good for gold. 

Price Targets?

Ok fine... I'll put everything on the line and give you a quarterly forecast profile... here goes: 

Q1: USD1850/oz 

Q2: USD1900/oz 

Q3: USD1950/oz 

Q4: USD2000/oz.

This is a bullish profile, I'm well aware, but the upside is there for the taking in gold. Let's see where we end up. Of course, I could be completely wrong :) 

The Last Line: 

Everyone thinks tapering / balance sheet runoff is bad for gold... that's not the case from the last cycle - note when gold exploded higher as balance sheet tapered lower. 

In my view, this could well be the case again. Gold is currently priced for the Fed perfectly, but in reality they are likely to make a mistake somewhere this year. Whether this is with excessive hawkishness, or allowing inflation too hot, gold will be a very much more attractive asset by the end of 2022 than at the end of 2021. 

Please do disagree in the comments below, or drop me an email at luke18032000@gmail.com 

December Nonfarm Payrolls Primer - Looks Like a Mug's Game To Me

Good Evening. 

Tomorrow will be the first Friday of the month, and that means it is time for the Nonfarm Payrolls report. No doubt, this is going to be a tricky report to read. On the one hand, there is all of the seasonal stuff and adjustments which occurs over Christmas holidays, then there is the COVID-19 disruptions still playing out with Omicron, on top of that we have a Fed which is becoming more and more hawkish, so the impact for markets may have to be a bit of a play it by ear approach. 

This one seems like a mug's game to me :) 

Nonetheless, despite the seeming difficulty of the upcoming report, I will do my utmost to guide you through it in my usual style. My main advice for tomorrow's report is don't expect the first move to be the last one. This payrolls report will no doubt take time to digest - with many moving parts like unemployment rates, participation rates, and seasonal adjustments. ALL OF WHICH means the initial ALGO REACTION may be over/underdone. 

Where are we now? 

Source: Refinitiv

The most important thing to remember is that we've had some pretty hefty shocks to the payrolls report over the last few months. The November number was miles from consensus with 550k estimates and 200k added. 

But this is not the only cog in the payrolls machine. We also have the unemployment rate (below) which has been trending down, but the Fed is probably not comfortable when we also consider that 4m fewer people are in work than before the pandemic. 

Source: Refinitiv 

Likewise, the participation rate has been pretty important. Following the ADP report on Wednesday, where a whopping 800k private sector jobs (apparently... always take ADP with a pinch of salt ;) ) were added (against consensus of 400k or so). If the participation rate ticks up noticeably, this will actually be a sign of dovishness since it means people are returning to the workforce, which in turn implies that inflationary pressures (particularly on wages) are likely to ease. 

If not, then the Fed may have a more severe inflation problem on its hands - particularly in those low skilled jobs where wages have had to rise dramatically in order to incentivise people back into the labour force. The participation rate can be seen below. 

Source: Refinitiv - Participation has lagged the decline in unemployment 

WHAT'S EXPECTED? 

Currently, the consensus estimate is for 400k jobs to be added and for the unemployment to drop to 4.1% from 4.2% prior. HOWEVER, the underemployment rate is expected to move higher! Despite a big increase in jobs! To me, this is saying the market is clearly expecting a bit of an uptick in participation this time around. 

There is a HUGE DISTRIBUTION though in the range of estimates, with Pantheon Macro top of the pile with 1.1m expected. 

Source: Refinitiv 

WHAT'S THE TRADE? 

For me, the only way to play this is via FX. If we get a big headline beat on the outright payrolls number EXPECT A KNEEJERK STRONGER USD. 

This would be in-line with the Fed feeling more comfortable about possible tightening. However, if participation / underemployment show there is increasing slack in the labour market, this could cause a pretty quick reversal. 

MY TAKE: 

My forecast is for a payrolls number around 800k - roughly in-line with the ADP forecast from the other day. 

Certainly, I think the balance of risks is to an upside surprise in payrolls - and if we get this along with other labour market metrics tightening - i.e. participation stubbornly low and under-employment not rising too much, this could be a pretty hawkish signal as it will be indicative of broader pressures in the labour market. 

This would obviously be negative for gold, bullish for USD, and bad for equities. The Fed has been very aggressively pivoting to a much more hawkish position however, and I continue to believe that the Fed acting too quickly is the biggest risk to the outlook for US equities, although it will be longer-term bullish for gold. 

The market is currently pricing in three Fed hikes this year already. To me, this seems mad, and I do believe that this is too aggressive for 2022, basically no matter what the payrolls report is. 

My advice, stay out of this one and watch from the sidelines. It's going to be brutal for someone at least :) 

Happy Trading. 

 

The Views for 2022

Hello to all and welcome back to my usual service of blog posting. This will be a short one today... although it could have dragged on for ages so for my brevity, you are welcome :) 

In this post, I'm going to outline very briefly my key views for 2022. 

Equities: 

UK & Europe continue to be preferred and the best value in the market. This is based purely on their relative cheapness to the US. But, the number you're all waiting for... my SPX target. I'm way more bullish than most on the street (below) and am expecting a year-end of around 5600-5800. This is, yes, a large range. But I mainly believe this because inflation pressures are likely to become more visibly diminishing as we enter a disinflationary environment (due to falling commodities prices). 

This has also been an extremely one-sided rally in equity market so far - with tech leading all the way (and even tech is too broad a term - more like megacap tech). I see a catch-up of value which will be the main driver of returns in 2022. 

There are a huge number of downside risks, but I will elaborate further in a specific report once my January exams are out of the way :) 

Treasuries: 

I'm a big fan of "steepeners" for this year. Particularly, I think the short-end of the curve is pretty much priced to perfection for a perfect hiking cycle. I do not believe the Fed will be hiking as aggressively as the market is currently priced for. Thus, I think the trade is for a steeper curve, as the 2y drops back a little from its aggressive pricing, while the 10y yield has room to rise further as slightly higher medium-term inflation expectations start to be baked in. Thus, I see a first Fed hike probably in July, and then I'd be surprised if we needed to see another one before the end of 2022. 

This though, will likely bake in that higher inflation expectation, which will allow the 10y to rise. Year-end, I see the 2y yield in the region of 0.8 - 1% (this as a result of a higher initial rate to begin with) and the 10y yield at 2%. This would give us 100bps of spread between the 2y and the 10y. 

Elsewhere, the story is less clear. In the UK, the Gilt market is expecting FAR TOO MUCH FROM THE BOE! Yes, I know my track record on the BoE lately is a little bit mixed, with one perfect call and one catastrophic, but nonetheless, the UK Money markets seem to expect 75-100bps of hikes this year! Madness in my view. 

In Europe, the ECB is the last man standing on the transitory front. I wouldn't be surprised if they dropped this in a meeting or two's time, but we shall see. To me, this means we can have some further upside for EUR rates, although I do not believe a hike or any kind of policy tightness will emerge this year. 

FOREIGN EXCHANGE: 

EURUSD: Bullish in the first quarter - everyone expects the Fed to engage in a quick tightening cycle. This probably is an incorrect view - we are nowhere near full employment. Consensus is for USD strength in 22, the consensus FX view last year was destroyed in a week... balance of risks is to definitely to the upside in EURUSD. 

Longer-term, see EURUSD probably ending a touch stronger on the year. 

Quarterly Profile for EURUSD

Q1: 1.14

Q2: 1.15

Q3: 1.15

Q4: 1.14

GBPUSD: 

Definitely weaker in the first quarter - priced for BoE to be rapid and this just isn't going to happen. See 1.32 as an initial target and possible weakening further into year-end - especially if the BoE remains quiet as I expect. After the initial shock of a more dovish than expected BoE, expect to see GBP follow the broader market. 

Q1: 1.32 

Q2: 1.33

Q3: 1.33 

Q4: 1.32 

TRADE IDEA FOR Q1: BUY EURGBP TARGETING 0.864

EURCHF: 

Come and say it with me... BUY EURO-SWISSIE... That's been my anthem for the last 3 months anyway (sorry for those who followed into the trade)... but I am close to re-evaluating on this. I think it will be interesting to see how the yields / havens story interacts over the next couple of months. 

USDJPY: 

As mentioned a few times, I think the market is expecting too much from the Fed, this could help the JPY in the short-term as it is very yield driven, but the rising 10y dynamic may also lead to some weighing on the currency, so I'm pretty neutral overall. 

COMMODITIES: 

GOLD - USD2000/oz by Year-end: 

We all know I'm massively bullish on gold, and I continue to have this view. We are USD300 lower than the all-time highs and the environment remains very monetarily accommodative despite surging inflation. At some point I think it regains its lustre and powers higher - I certainly don't see much more downside provided the USD1760/oz low which has been observed continues to hold. 

OIL: 

Moves to the downside - OPEC+ cohesion isn't going to last long with oil at these prices. Also US shale will likely be incentivised back to the market in greater fashion. Worst of the shortages seem to be over... expect year-end Brent around USD75. 

The December Reading List

Happy New Year to all my readers! I hope you all had a fantastic Christmas, New Year and are looking forward to a bright and prosperous year ahead. 

Once again, we've arrived at one of the reading lists. This one is going to be slightly extended as I go through my usual review of books from the month and also I've got a little bit of a highlights reel at the bottom - putting together my top 5 picks of 2021 which I'd recommend to everyone (i.e. they won't be ultra-niche finance or economics). 

I managed to get through all the books on the reading list for December in pretty good time, but a heads up straight away I have January exams at university so I'm only aiming to read four books instead of the usual five to avoid overpromising/under-delivering. 

Well without further ado, I present the December 2021 reading list. 

Barack Obama - The Audacity of Hope: 

I picked this one up since I realised I hadn't read any of Barack's earlier writings from before he became the President. Specifically, this was written in around 2006 when he was still just a Senator and notions of becoming the President still hadn't fully crystallised / come to the fore. 

The book is split up into a number of sections where Barack gives his opinions on everything from foreign policy to race issues to healthcare. 

I particularly enjoyed sections related to inequality and the nuanced perspective which Obama provides here is very telling and interesting. Some of the solutions outlined were later key policies in his government (particularly around Obamacare etc). However, (and I'm about to be brave and criticise a former President - easy with hindsight) I do feel like many of the foreign policy views he expresses here were the foundations for errors during the Obama Administration. There appears almost a certain naïveté and I do wonder if asked to revisit these views Obama would have changed some of them knowing with the gift of hindsight the consequences of America not being a balancing force in the world. 

Nonetheless, I particularly enjoyed this book and would highly recommend it as it provides a telling insight into the views which shaped many of the Obama administrations policies. 

Lee Child & Andrew Child - Better Off Dead (Reacher 26): 

I'll keep this section short and sweet. I love a Jack Reacher novel, although I've only read about five of them (the first 4 and then this). If, like me, you're in a position where you have read a couple but not the most recent, fear not. The book is easy to jump into and in usual Lee Child style does not depend on the previous iterations. 

It's compelling, easy to read and very gripping. Plus it's half price at Waterstones at the moment, so head over and pick it up for a little entertaining light reading. 

Mark Moffett - The Human Swarm: 

This one I picked up on a bit of a whim, but it actually fits in very nicely with a lot of my previous readings. Specifically, I thought this was a natural extension of both Kahneman's Thinking Fast and Slow and The Righteous Mind by John Haidt. One of which, you'll notice later, features on my top five picks. 

This doesn't quite make the cut, but it is a very interesting perspective. Moffett is from a biological background, and therefore makes a number of interesting comparisons between humans and other species, touches on why we form societies (both at national and individual levels) and delves into some of the more biological / natural drivers of our internal prejudices. The lessons from the book really are on how we can be aware of these inbuilt prejudices and fears and how we can work to still build better societies in spite of these prejudices. 

Hamilton, Madison & Jay: The Federalist Papers 

Ok, this one was a bit nerdy and I confess I might have bitten off a little more than I could chew here. But nonetheless, after some very close reading of a number of very intricate passages, I did manage to wrap my head around a number of these Federalist Papers. 

For those who have no idea about American history, please do skip ahead, but this was an insight (in a collection of 85 essays written by Hamilton (of the musical), Madison (the fourth President) and Jay (the first SC Justice) into the workings of the constitution. The aim of the papers was to provide a rebuttal to a number of the criticisms of the unratified constitution and accelerate the process of forming the Modern United States of America. 

There's a lot of legal stuff in here, which I didn't have the knowledge to digest properly, but the sections on the respective roles of the branches of government are insightful. 

It's a difficult read, with long-winding sentences and complex archaic words, but if you're interested it's definitely worth a try. My favourite was No. 69, where Hamilton explains how a President under the proposed constitution would not be at all like a King. The fears of dictatorship are persistent, and we must be very grateful to the founding fathers for being so scared of possible exertions of power, and building a system which has proved extraordinarily resilient - even in the face of massive pressure in the last few years. 

Rick Atkinson - The British are Coming: 

Then the last book of the month, The British Are Coming. This was another one which I greatly enjoyed. Regular readers will know I've read a few books on the Revolutionary War this year, and this was by far the most digestible to the lay reader. 

I also read 1776, which was a lot more detailed on this specific part of the history, and Chernow's magnificent biography of George Washington, which was a little dry in places but again very detailed. 

Atkinson is brilliant at creating a marvellous narrative, and everything links together beautifully in this construction. 

However, I am going to make a criticism here which is Atkinson fails to focus enough on Rebel force weaknesses. Sure, the utter hopelessness of the cause at times does come across, but there is nowhere near the level of attention to detail of how close Washington & Co. come to failure as in some of the aforementioned books. 

Thus, this is ideal for the lay reader who wants to have an easy and digestible history of this critical period, but for more serious scholars I would probably look elsewhere. 

THE TOP 5 OF THE YEAR: 

I'm not going to re-write my previous analyses of the books mentioned below, just going to name them and redirect you to the relevant Reading List. 

1. Thinking Fast And Slow - Kahneman

2. A Promised Land: Barack Obama 

3. Fantasy Land - Kurt Andersen

4. Extraordinary Popular Delusions and the Madness of Crowds - Well worth another read given all the speculative manias going on in financial markets at the moment! 

5. The Return of a King - William Dalrymple - This book was simple incredible. The insights into Afghanistan wars past and present is simply invaluable. A magnificent guide to history which I recommend to all. 

So that's it for 2021 reading lists, but there will be much more to follow in 2022! 

Books for January: 

1. The Bourne Identity - Robert Ludlum 

2. Richard Nixon: The Life - John Farrell 

3. Value(s): Climate, Credit, Covid and How We Focus on What Matters - Mark Carney

4. Mastering The Market Cycle - Howard Marks 

As always, please reach out with your suggestions, recommendations and questions. 

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