Short AUD/CAD and NZD-NOK to Avoid RoRo: HSBC

With risk being a dominant driver of currency direction traders are left exposed to a two-way play. However, there are currency pairs out there with a low enough correlation to risk-on / risk-off for traders looking to avoid this driver.  David Bloom, Strategist at HSBC Bank plc writes:

"Risk on − risk off" (RORO) has returned, as highlighted by our quantitative strategists.

This has coincided with outperformance by many of those currencies often described as "risk on" − higher yielding, commodity currencies, and EM FX more broadly.

On 9 March we highlighted why we believed that EM FX was in a "purple patch" and would continue to outperform.

However, we also stated a preference for discretion, with our favourite longs being those with positive or improving local stories.

The idea was that as negative external forces diminished, local factors would matter more.

To try and avoid the RORO factor would mean avoiding pairs with the strongest correlations to RORO and expressing a view based on local factors amongst currencies with low correlations to RORO.

Returns are likely to be smaller, but should come with less volatility and less external risk.

Short AUD-CAD

The CAD has been sold as a proxy for lower oil prices in recent years, in our view unfairly.

Energy accounts for only around 13% of Canada’s total goods and services exports, and annual export growth has shifted into positive territory for the last three months. The loosening of fiscal policy should also support the economy, meaning less need for further interest rate cuts.

On the flip side, further interest rate cuts are expected in Australia after the RBA surprised the market by cutting its policy rate on 3 May to a new record low of 1.75%.

We think this will keep the AUD under downward pressure in coming months.

• Related: Credit Agricole: Forecasting Extension of Australian Dollar Weakness
• Australian Dollar Now Most Vulnerable to USD Turnaround in G10 Warn Citi

Short NZD-NOK

We think the NOK is one of the fundamentally soundest currencies in the world, given Norway’s sizable fiscal and current account surpluses.

It is very cheap, having sold off in line with oil prices last year, but it does not deserve this undervaluation given the economy is actually diversified from oil receipts through the government's petroleum fund.

Meanwhile we see the RBNZ cutting rates this year and remaining uncomfortable with NZD strength.

Long MXN-BRL

The MXN has suffered at the hands of “risk off” phases but we are more positive on local factors. The central bank has hiked rates 50bp, shifted its intervention policy to a more effective ‘ad hoc’ stance, and oil prices have recovered from their lows.

We see room for the MXN to perform well in a risk on environment, but a lower oil price would be a key risk, especially given investors’ concerns that state owned oil company Pemex could lose its investment grade later this year. The BRL has performed well of late, helped both by external “risk on” factors and by better.