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In 2022, global central banks had a common enemy. Everyone was unified in raising interest rates to fight inflation.

But, in 2023, there are early signs there could be sharp divergences between central banks and their priorities.

This week, the Fed seemingly doubled down on its hawkish message. Down in Australia while the RBA hiked rates, their forward guidance was more dovish.

Shifts in different country's relative policy stance will have huge ramifications for investors. That's true across asset classes but arguably currencies are at the sharp end of this. Even if you don't trade FX, this is an important market to watch.

In FX, interest rate differentials are often decisive. But not always. In 2023, knowing which currency pairs are being driven by rate differentials is going to be critical.
Image 1
The chart above looks across G10 fx pairs and ranks where rate differentials feature as a driver. The y-axis simply shows whether interest rate spreads screens as the top driver, or holds less sway within Qi's models.

This is the first step in the pre-trade process.
  • step one - know which fx crosses will react most as interest rate markets move to reflect shifts in different central banks' policy stance.
  • in this instance, Aussie and Canadian crosses stand out as ones where cross-market rate spreads really matter. Yes both are resource-rich countries and that may lead some to use them as China proxies. But right-here-right-now, it is the RBA's and BoC's policy stance that matters more.
  • for the US Dollar, if you have a strong view on the Fed (whether hawkish or dovish pivot), don't trade USDCHF. USDJPY and USDNOK will be more efficient.
  • for the Euro, EURNOK reflects the ECB / Norges Bank reaction function. EURUSD is not currently a nominal rate differential play. Real yields matter more; and global growth considerations and credit markets matter even more still.
  • step two - screen out the models that are not in regime (greyed out dots in the chart above) and focus on those where macro is the dominant narrative (red dots rather than grey).
  • step three - add in the Qi valuation overlay. For example, USDNOK and AUDUSD have the biggest Fair Value Gaps. Both show the USD as having done a fair amount of work discounting the idea of a more hawkish Fed. And, in the case of the Aussie, now a more dovish RBA.
Divergence is going to be a big theme in 2023. Think China versus the US. Not just the politics but the contrast between Fed tightening and potential PBoC easing over this year.

Understanding what is driving asset prices is a critical first step in any investment process. #measuringmacro
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