Central Bank Watch Overview:
- Recent shifts in policy by both the Bank of Canada and the Reserve Bank of Australia have made it increasingly unlikely that either central bank takes the dramatic step of cutting their main rate into negative territory.
- All three of the commodity currency central banks – the BOC, RBA, and Reserve Bank of New Zealand – have seen dovish rate cut expectations scaled back significantly in recent weeks.
- Retail trader positioning suggests that the commodity currencies are on mostly bullish footing (bullish AUD, CAD; neutral NZD).
Bank of Canada Eyes the Long Game
The Bank of Canada’s October policy meeting may prove to more significant in hindsight, despite no change in interest rates. The firm promise by BOC Governor Tiff Macklem that “if you are a household considering making a major purchase, if you’re a business considering investing, you can be confident that interest rates will be low for a long time,” has pushed out any expectation for any interest rate hikes for several years: through 2023.
Bank of Canada Interest Rate Expectations (NOVEMBER 20, 2020) (Table 1)
To this end, interest rate expectations have evaporated due to the clear forward guidance offered by BOC Governor Macklem. Three months ago, in mid-August, there was a 17% chance of a 25-bps rate cut by December 2020. Now, there is a 0% chance for December 2020, an expectation that carries through September 2021.
For weeks, we’ve said that “it would appear that the Bank of Canada’s efforts along the interest rate front are finished…if the BOC does anything else, it may not be to cut interest rates to zero – or to negative territory.” Accordingly, the decision to shift the composition of the BOC’s QE program towards long-term bonds is an effort to keep interest rates as low as possible without explicitly dropping the main overnight cash rate into negative territory.
IG Client Sentiment Index: USD/CAD Rate Forecast (NOVEMBER 20, 2020) (Chart 1)
USD/CAD: Retail trader data shows 71.74% of traders are net-long with the ratio of traders long to short at 2.54 to 1. The number of traders net-long is 3.00% higher than yesterday and 2.27% higher from last week, while the number of traders net-short is 0.35% higher than yesterday and 6.58% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall.
Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/CAD-bearish contrarian trading bias.
Reserve Bank of Australia Looks at a Rate Cut
The Reserve Bank of Australia’s November policy meeting produced a 15-bps rate cut as expected, but the more significant development was the shift in focus for policymakers. RBA Governor Philip Lowe said that “Labour markets are working differently than they used to and wage and inflation dynamics have changed…given this, we have now moved to place much more weight on actual outcomes, rather than forecast outcomes, in our decision making and our forward guidance.” In effect, this means there will be a greater focus on actual labor market outcomes (e.g. the unemployment rate) over expected price pressures.
RESERVE BANK OF AUSTRALIA INTEREST RATE EXPECTATIONS (NOVEMBER 20, 2020) (TABLE 2)
According to Australia overnight index swaps, there is between a 22 to 25% chance of a rate cut through December 2021, which appears to be nothing more than a pricing quirk due to the RBA’s extraordinary efforts to institute yield curve control. The RBA will be keeping its overnight cash rate at 0.1% or lower for at least the next two and a half years.
IG Client Sentiment Index: AUD/USD Rate Forecast (NOVEMBER 20, 2020) (Chart 2)
AUD/USD: Retail trader data shows 32.03% of traders are net-long with the ratio of traders short to long at 2.12 to 1. The number of traders net-long is 0.41% lower than yesterday and 1.98% higher from last week, while the number of traders net-short is 0.79% higher than yesterday and 5.09% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests AUD/USD prices may continue to rise.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger AUD/USD-bullish contrarian trading bias.
Reserve Bank of New Zealand on Hold, but Dangles Negative Rates
The RBNZ is continuing to engage in a game of ‘will they or won’t they’ as it pertains to a cut to the main overnight cash rate into negative territory, having teased such an occurrence for six months now. But the November RBNZ rate decision produced no such development, even as policymakers led by Governor Adrian Orr hinted that they remain “prepared” to reduced the overnight cash rate “if required.” Extraordinary performances in the New Zealand housing and labor markets in Q2’20 and Q3’20 have limited the need for such extreme efforts in the near-term.
RESERVE BANK OF NEW ZEALAND INTEREST RATE EXPECTATIONS (NOVEMBER 20, 2020) (Table 3)
To this end, market participants haven’t thrown in the towel on negative interest rates, but such a development is no longer discounted anytime in the near future. Indeed, the RBNZ overnight index swaps (OIS) curve is suggesting that the main interest rate will fall to 0% by May 2021, but there is no clear expectation for any move to negative territory though October 2021.
IG Client Sentiment Index: NZD/USD Rate Forecast (November 20, 2020) (Chart 3)
NZD/USD: Retail trader data shows 23.19% of traders are net-long with the ratio of traders short to long at 3.31 to 1. The number of traders net-long is 5.58% higher than yesterday and 18.18% higher from last week, while the number of traders net-short is 0.73% higher than yesterday and 31.24% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests NZD/USD prices may continue to rise.
Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed NZD/USD trading bias.
— Written by Christopher Vecchio, CFA, Senior Currency Strategist