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Will AUDUSD cross a key line in the sand?

Posted on: 29 April 2019 , by: Darren Sinden , category: Market Review

As I write, we’re at what looks to be a pivotal point in AUDUSD: the round number of 0.70. This level has held on previous occasions. Will 0.70 hold this time? Or will it give way and open the door to lower levels?

Secondly, what are the drivers for the recent move down in the Aussie dollar? 

Let's try to answer those questions and identify the trading opportunities that will accompany the next move in AUDUSD rate.

Divers for change 

I have written regularly over the last 18 months about the issues confronting the Australian economy and the Reserve Bank of Australia (RBA). In summary, Australia has not seen a recession for more than 25 years and the central bank has kept Aussie interest rates on hold since July 2016, when it cut them to 1.50%.

Markets had hoped the next move in interest rates would be higher. However, those hopes were dashed at the end of 2018 when it became clear the underlying economy was exhibiting signs of slowing down - or even contraction. 

The annualised GDP growth in Q4 2018 fell to just 2.3%, well below the 3.1% seen in Q1 and Q2. The rate of growth slowed as well falling to only +0.20% in Q4 2018 compared to the long term average of +0.85%.

Falling prices  

Over the course of 2019 inflation has started to fall in Australia. That might be thought of as good news for consumers, and it probably is in the short term. However, inflation is not just a measure of rising or indeed falling prices. It is also a barometer of demand, and that is how central banks view it. They like to see moderate levels of inflation, implying that demand is outstripping supply, which needs to be increased to meet demand and that the economy is growing as a result of that interaction.

The RBA warned in its most recent meeting minutes that a combination of falling inflation and rising unemployment could lead to another rate cut. Weak inflation data, that followed a tick-up in the March unemployment rate, delivered just that, and markets took the bank at its word. In the immediate aftermath of the inflation data, swap rates in Australia suggested that there was a 60% chance of a rate cut in May and both JP Morgan and Citigroup highlighted the possibility of back-to-back rate cuts in May and June.

Headline and core inflation measures (% change YoY)

Australian inflation has tailed off.

The RBA is due to meet on the 7th of May. However, I am wondering if the bank will take any action this month, simply because Australia has a general election just 11 days later, on the 18th of May. Central banks avoid making policy changes at such times if they can. 

Having waited almost three years to pull the rates trigger, perhaps the RBA can hold out just a little longer.

The technical picture 

The fallout in AUDUSD from the inflation data can be seen very clearly in the chart below. 

At the time of writing, the Aussie dollar fell by more than two percent over the previous seven days, testing back to and briefly through the key round number of 70.00 as it did so.

In truth, there is nothing special or unique about that figure. However, it does resonate with traders and as a result, it has become psychologically important. The New Year flash crash aside, AUDUSD hasn't closed below here on a weekly basis since the emerging market sell-off in January 2016, more than three years ago. 

It would be fair to say that 0.70 is a line in the sand that won't easily be crossed if history is any guide. If you look at charts as part of your trading process, then by default you believe it is.

If the round number isn't broken and here we mean a weekly close below it, then what should happen next? Logic suggests that some kind of bounce or retracement is in order.

The fact RSI 14 is moving towards the oversold boundary of 30 could be seen as backing up this idea, though of course it could overextend and move lower still. 

Retracement levels 

On the assumption that it doesn't and that 0.70 does indeed hold firm, what might we look for on the upside?  

If we apply a Fibonacci retracement to an hourly chart of the rate and the recent moves in it (see above) we can get an idea of what might be possible and the levels to look out for.

Starting with the 23.6% line at 0.70178, followed by 0.7022, which was resistance intraday on the 24th and 25th of April, then the 38.2% line comes in at 0.70325 after that, followed by the 2nd of April low of 0.70526, finally, old support from late March found at 0.70655.

Ideally, the entry into any long trade would be as close to 70 as possible, though stop losses could be placed below the recent low of 0.6988.

 

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