Much is usually written at the beginning of each year with forecasts (that are fairly discretionary, in my opinion), so why not add to the clutter!
Commodities and Inflation
One of the biggest themes emanating from the COVID-19 crisis were supply chain-linked increases in commodity prices – especially agricultural commodities. Be it wheat, soybeans or corn, the entire basket of “ags” stayed well bid. In fact, many other commodities including coffee, oats, lumber, etc. increased further into 2021.
A great way to view the overall agricultural commodity space is via the Invesco DB Agricultural Fund ETF (symbol DBA: NYSE).
DBA ETF (Soybeans, Corn & Wheat are ~38% of this ETF)
Here we have a ~38% weighting in this index tilted towards soybeans, corn and wheat. The low seen in June 2020 looks like a secular (i.e. long term) low, and I’m of the premise that commodities should stay bid overall.
So, given the potential for US rate hikes + tapering, I expect commodities to pullback slightly in 2022 (with exceptions, WTI oil being one). However, I am still long term bullish on commodities and think we – finally – have the environment where we will see sustained capital allocation into this asset class.
Powell's Last Chance
Arguably, Powell’s and the US Fed’s reputation has been tarnished by not getting the inflation call even remotely correct. Readers are probably already familiar with their “transitory” inflation call over the past +1 year. And now that the market has clearly signaled inflation is far more than transitory, the Fed is finally flinching by indicating short term interest rates are going up into 2023/2024 – albeit at a slow pace. Not raising rates (which is a possibility, but not a probability) would be catastrophic in many ways, and against the Fed’s recent narrative.
Monthly US Inflation (25-year lookback)
This is a conditional forecast based on monthly inflation staying below 1%.
The Fed finally caving into market pressures feels like a “sell the news” event, so while I expect short term US interest rates to rise they will do so at a very gradual pace. There are many reasons for this, but one of the biggest is the well-understood risk that raising US rates too high/too quickly will have a meaningful negative impact abroad. Most foreign governments borrow in US dollars (effectively being short USD), so any rate hikes would attract on a relative basis more capital into the US dollar, potentially impacting foreign sovereign debt markets.
However, should US inflation breakout above 1% we could see the Fed accelerate their rate hike cycle.
Long term I am bullish on the USD overall. By “long term” I mean for the better part of this decade. It’s difficult to get too negative on the US dollar just yet.
I’ve mentioned above that while I expect commodities to weaken slightly in 2022, I have highlighted that crude oil will likely continue to get bid this coming year. This is clearly CAD-positive.
However, the US will likely outpace Canada for its interest rate hikes (marginally only), so on an interest differential basis this clearly favors USD.
So, when you net both these out, I think the most likely scenario in 2022 is for a volatile, yet choppy, even sideways forecast for USDCAD.
We are likely to see a choppy, and potentially large, trading range in USDCAD for most of 2022. I expect the currency to react more acutely than normal to interest rate guidance by both the US Fed and Bank of Canada. The market has not quite found its footing in terms of pricing rate hikes, and on the US side there has been a big divergence between central bank guidance and market pricing (see below).
I am of the premise that any major pullback in US dollar is a fantastic opportunity for corporates with USD payables (e.g. importers) to think about long term hedging.
Until next time…
Alexander Grant, FRM is Olympia Trust CGP’s Head of FX Options Trading. He can be reached at firstname.lastname@example.org if you have questions.
Information provided is for informational purposes only. It is not investment or trading advice, or solicitation for the purchase or sale of any financial instrument.