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RBA is scheduled to be announced its cash rates today during Australian hours, Our RBA outlook (on hold for some time) is anchoring short-maturity interest rates and should keep 3yr swap rates in a 1.8% to 2.3% range, as long as core inflation remains below 2%. Longer maturity rates will largely follow US rates. We foresee bullish AUD if the Australian central bank adopts a more hawkish tone to its communications.
While Japan and Australia the two outliers where policy either remains resolutely dovish or unchanged in the face of a global tightening. The resulting policy divergence can be expected to play out in FX markets most forcefully on the crosses; for the purposes of analysis here, we have factored out the USD for the most part as a relative rates play (except USDJPY) on grounds that Washington dysfunction can continue to muddy the waters and trump clean cyclical effects for dollar pairs.
The two currency pairs where options offer the maximum value in positioning for rate divergence are AUDSGD and USDJPY. This assessment is based on a comparison of the spot-to-strike distance of digital options in the direction of expected currency moves with the distance from current market to the most extreme YTD spot levels in the same direction, the latter acting as a proxy for the extent of maximum currency moves.
The deflator is far from perfect and perhaps unfairly penalizes Euro-bloc currencies that have already experienced decent spot moves, but crudely maximizes utility for a value investor in search of relative laggards. USDJPY’s ability to act as a hawkish Fed stand in requires no exposition.
AUDSGD is an interesting one to consider heading into the October MAS meeting that is expected to prepare the ground for the introduction of a 50bp positive slope of the SGD NEER band at the April 2018 meeting(see Positive policy slope on its way, albeit in 1H18, and could sponsor further SGD strength. USDSGD is short for now; AUD can be a useful currency to diversify SGD longs against since it provides some equity-weakness. Courtesy: JPM
