Central Bank Watch Overview:
- Many central banks have reached the lower bound of interest rates – for now. Some central banks have even started quantitative easing (QE), which was avoided during The Great Recession.
- The commodity currencies, AUD, CAD, and NZD, which typically benefit from their higher yield profile relative to other currencies (the carry trade), no longer hold this advantage.
- Retail trader positioning suggests that the commodity currencies may still have gains ahead of them yet.
Central Banks Keep Rates at Lowest Levels Ever
The coronavirus pandemic continues to rage, posing a unique threat to the global economy unforeseen since The Great Depression. G10 currencies’ central banks are acting in a more significant manner, announcing record low interest rates and asset purchase programs that were deemed ‘too extreme’ during the last crises, The Great Recession and Eurozone debt crisis.
It’s not just the major central banks like the Federal Reserve and European Central Bank either. Every single central bank associated with the eight major currencies covered by DailyFX are holding their main interest rates to all-time lows.
Although the commodity currencies no longer hold the relative yield advantage that defined ‘the carry trade,’ it still holds that these currencies – the Australian, Canadian, and New Zealand Dollars – retain significant economic exposure to agriculture and base metals, making them prime vehicles for speculation around a rebound in global growth.
Bank of Canada Rate Cuts Done for Now
The Bank of Canada’s efforts along the interest rate front may not be complete after all. Despite immediately cutting the main interest rate to an all-time low of 0.25%, the BOC has been offering some signals to the market that it may not be done yet. At the April BOC policy meeting, rates were kept on hold while new financial market stability mechanisms were announced in order to help keep credit flowing to businesses and households. Since then, interest rate expectations have slowly been dragged forward.
Bank of Canada Interest Rate Expectations (May 21, 2020) (Table 1)
According to Canada overnight index swaps, rates markets think that the BOC is going to move on rates again by the end of the year, even if more is being done to gear-up extraordinary policy efforts. One month ago, through the end of the year, there was only a 5% chance of a rate cut materializing; now, overnight index swaps are pricing in a 55% chance of a 25-bps interest rate cut in December 2020.
IG Client Sentiment Index: USD/CAD Rate Forecast (May 21, 2020) (Chart 1)
USD/CAD: Retail trader data shows 63.35% of traders are net-long with the ratio of traders long to short at 1.73 to 1. The number of traders net-long is 14.35% higher than yesterday and 114.33% higher from last week, while the number of traders net-short is 1.62% lower than yesterday and 35.17% 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 May Cut Rates Again
The Reserve Bank of Australia has already sliced its main overnight interest to an all-time low of 0.25% after five rate cuts over the past year, but markets feel that the RBA may not be done yet. After all, the RBA surprised some by announcing its own quantitative easing (QE) program, a step that was not taken during The Great Recession. This pursuit will achieve the goal of keeping the three-year bond yield at 0.25% for the next three years. It may take more to achieve this goal, however.
RESERVE BANK OF AUSTRALIA INTEREST RATE EXPECTATIONS (MAY 21, 2020) (TABLE 2)
According to Australia overnight index swaps, there is a 53% chance of a 25-bps rate cut at the June RBA meeting. But given the commentary from RBA Governor Lowe suggests that the central bank is not prepared to move rates into negative territory, making any further rate cuts unlikely; the pricing may be a quirk due to the shape of the Australian bond yield curve.
To this end, the RBA has said that it will target the three-year bond yield at 0.25% - the same rate as the overnight cash rate – which is a reasonable assumption that the RBA will keeping its overnight cash rate at 0.25% or lower for at least the next three years. Like the RBNZ, lower rates may be coming soon for the RBA – just not quite yet.
IG Client Sentiment Index: AUD/USD Rate Forecast (MAY 21, 2020) (Chart 2)
AUD/USD: Retail trader data shows 37.23% of traders are net-long with the ratio of traders short to long at 1.69 to 1. The number of traders net-long is 15.11% higher than yesterday and 5.27% lower from last week, while the number of traders net-short is 6.88% lower than yesterday and 10.90% 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.
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 AUD/USD trading bias.
Reserve Bank of New Zealand Not Done Yet
The Reserve Bank of New Zealand convened an emergency meeting on March 16 to slash rates by 75-bps, cutting the main overnight cash rate to an all-time low of 0.25%. The coronavirus pandemic has not hit the New Zealand economy has hard as other developed economies, but that hasn’t stopped the RBNZ from going to its most extreme easing stance in its history in order to buffer the economy from contagion.
To this end, as part of the emergency interest rate cut, the RBNZ made clear that it would begin forward guidance, indicating that the main interest rate would stay at 0.25% for at least the next 12-months. But that doesn’t more can’t be done: the RBNZ noted that 0.25% “was currently the lower limit, given the operational readiness of the financial system for very low or negative interest rates.”
But at the May RBNZ meeting, the tone changed. “The committee noted that a negative official cash rate will become an option in the future, although at present financial institutions are not yet operationally ready,” the RBNZ said.“It was noted that discussions with financial institutions about preparing for a negative OCR are ongoing," which "will become an option" in 2021.
RESERVE BANK OF NEW ZEALAND INTEREST RATE EXPECTATIONS (MAY 21, 2020) (Table 3)
For now, markets are interpreting the commentary from the RBNZ that, while lower interest rates may be coming, they may not arrive in 2020. Through the last meeting of the year, the November RBNZ meeting, there is a 28% chance of a 25-bps rate cut – down from 37% one-month ago.
But against the backdrop where more dovish policy action has been hinted at by RBNZ Governor Orr, including extraordinary policy measures such as QE, then it would be shortsighted to dismiss the possibility of a rate cut arriving before the year is out.
IG Client Sentiment Index: NZD/USD Rate Forecast (MAY 21, 2020) (Chart 3)
NZD/USD: Retail trader data shows 28.99% of traders are net-long with the ratio of traders short to long at 2.45 to 1. The number of traders net-long is 6.38% lower than yesterday and 38.03% lower from last week, while the number of traders net-short is 63.83% higher than yesterday and 73.31% 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.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger NZD/USD-bullish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
