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TradingAUDGBP

Playing Policy Divergence

cryptoburst
Market Analyst
Feb 8, 2023
Having, broadly speaking, tightened policy in unison over the course of 2022, the start of this year has seen G10 central banks take diverging paths. As the respective policy outlooks shift, this creates not only heightened market volatility, but also the opportunity to take advantage of said divergences as they pan out.

When looking at the G10 FX space, it seems logical to classify central banks, and therefore currencies, into three distinct buckets, based on where they stand in their respective tightening cycles. The first of these is the ‘determined hikers’, where we can place the ECB and the RBA, both of whom are resolute in their desire to tighten policy rapidly, and continue rate increases into the spring. The Fed can also be placed into this bucket, with the caveat that the market doesn’t appear to be paying much attention to guidance emanating from the FOMC.

In the second bucket, we find ‘reluctant hikers’, those central banks which are coming to the end of the hiking cycle, and/or are having to be dragged kicking and screaming by the market to tighten policy despite what some policymakers may desire to do. The Bank of England fall firmly into this category.

Finally, we have those that have concluded their tightening cycles. The Bank of Canada find themselves in this camp, with other G10 central banks – such as the Norges Bank and Riksbank – are likely to do so in relatively short order.

This presents some interesting trading opportunities, taking advantage of the divergences currently panning out, using the reluctant hikers, or those who have concluded their tightening cycles, as funding currencies for long positions in those with hiking cycles that have some room left to run.

Scanning the charts, AUD/CAD is one that jumps out, trading the aggressive RBA against the cautious BoC.

The bulls have managed to hold price north of the 50-day moving average on two occasions, with the market now moving towards a test of the long-standing 0.9330 level. A closing break of this level would further embolden the bulls, who would likely target a return towards the 0.95 handle.

It must be said that the CAD doesn’t have especially much going for it at the moment, with the domestic housing market on incredibly shaky ground, the BoC on pause and looking to cut possibly as soon as Q3, and with the outlook for commodity prices – especially oil – starting to soften. Of course, the risk to this trade idea is that one, or more, of these factors reverse course, invalidating the view.

Sticking with the AUD theme, one may also want to consider a short GBP/AUD position, as another way to take advantage of the gulf between the resolute RBA, this time versus the reluctant BoE. The chart is not quite as clear-cut here, though we have been in a well-established downtrend since the start of December, which has seen price move below all of the 50-, 100-, and 200-day moving averages.

Buyers have currently held the 1.7250 level firm, hence we’d need to see a closing break below here in order to provide more firm backing to the short idea. If this were to happen, however, there seems little by way of support until we near the 1.70 figure.

You’ll note, I’m sure, that there has thus far been little mention of the USD in this piece. The reason for that is that, while Chair Powell’s ‘higher for longer’ rhetoric has been resolutely hawkish, it has largely fallen on deaf ears as far as the market is concerned. This significant disconnect makes calling the greenback’s direction rather difficult at the present juncture; however, if the market were to begin pricing out cuts in H2 23, long USD would begin to become much more attractive, particularly bearing in mind the upside data surprises seen of late.

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