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AUD trader: What causes AUD to hit 60c?

On Friday, the AUDUSD sits at an 11-year low, taking the YTD losses in the pair to 5%, with the trade-weighted AUD also at the lowest levels since 2009. Only the NOK has fared worse in G10 FX this year, which is unsurprising given Brent crude hones in on $50 and WTI crude oscillating around the figure.

The set up on any time frame above four-hours fascinates, as there has been rock solid support below the 67-handle really since early August. While price closed through this support on Friday, it still needs work to erode the bids and offer higher conviction on a full resumption of a bearish trend. It can’t be ruled out given rallies seem to be limited to 50-pips.

We can then take the time frame out a touch and see trend support (drawn from the 2015 lows) at 0.6656, which is effectively the last bastion of clear technical support until the October 2008 and post-GFC low of 0.6009. If I were trading this from the short side, I would be adding to short positions on a close through 0.6656.

AUDUSD daily chart

The RBA seems too optimistic

The interesting aspect here is the RBA, while maintaining its easing bias in the last paragraph of the February meeting statement, have offered a more glass half-full outlook. Lowe cautioned that further interest rate cuts would just encourage increased debt levels, while acknowledging that he was pleased that house prices had risen of late.

Clearly, the barrier to cutting again have risen, and in some capacity the RBA see structural headwinds to their mandate, where to get anywhere near the banks 2-3% inflation target (in two year time) “we’d need to cut interest rates 3 or 4 percentage points than where we are now, so it's just not practical at the moment".

It’s hard to disagree with this call, and rates traders have responded, pushing out the probability of a rate cut in the March meeting to just 10%, 29% for April, with the May meeting a coin toss at 46%. We can look further out and see 31bp basis points of cuts priced over the coming year, having fallen from 44bp seen in the week prior.

The AUD as a China proxy

The question is whether changes in interest rate pricing really dominate the variance of the AUD here when the greater influence seems to be the shape of the Chinese economy in Q1 and beyond given the radical actions of Chinese authorities to contain the Coronavirus. Traders are buying USD’s on a broad basis, given its status as the best house in a bad neighbourhood, or the least dirty shirt, with capital moving as far away from China and those countries with incredibly close economic links, such as New Zealand and Australia.

One also suspects the market is highly skeptical that the RBA will be on the money with its latest forecasts and assumptions for growth, with its Q420 GDP forecast cut to 2.7% (in the recent SoMP), which is already 40bp above the consensus. I’d then argue that the consensus is too high. given it is affected and skewed by calls for GDP above 3% and this will soon be downgraded.

Growth aside, it’s the labour market that is key, which is a worry given it is a lagging indicator in many capacities. My preferred leading indicators, including ANZ job ads, or NAB capacity utilisation rates, suggests upside risk to the unemployment rate in the next two to three quarters.

This puts the next two employment reports (19 March and 16 April) as potentially setting the stage for a cut in May, with May heightened by the fact we have Aussie Q1 CPI print on 29 April. Of course, should we see financial markets really roll over, causing a sharp tightening of financial conditions, then a cut in March or April become more likely, but in this environment we’re likely to see rate cut expectations ramp up globally and not just in Australia.

The RBA should change the mindset of the consumer

My own view, is the RBA need to evolve and engineer animal spirits in Australia. Change the psyche of the consumer, get them spending and not just through heavy discounting. This could entail getting well ahead of the curve - get the cash rate down to the lower bound, suggest QE is a policy tool they are locked and loaded to use, put the wind to the AUD’s back and import inflation. Offset the risk to asset prices and debt levels with macro prudential., then hope China has done enough over the coming weeks to contain the virus and US economics stay firm ahead of the US election.

This perhaps all sounds rather simplistic, but with the reflation trade on ice, this message is clear in the bond and commodity markets, the AUD will look less at domestic factors and become a vehicle for expressing the economic prowess of the Chinese economy. Should we get any chinks in the labour market, the AUD will find sellers all too easy to find and the gulf between 0.6656 and 0.6009 will be filled rather quickly.

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