We have argued that the AUD in 2016 is facing a perfect storm scenario and was ripe for a long call for the following reasons.
The perfect storm factors
- Carry trade – AAA sovereign rating, a budget in relatively good shape compared to global peers, and bond yields over 200 basis points ahead of global peers.
- Commodity bounces – iron ore is clearly a public and private firm positive, the oil price bounce is a risk on positive seeing risk currencies returning, and also industrial metals, with copper particularly positive for a China-trade-story which brings the quasi-China currency in the AUD to the fore.
- Reserve Bank of Australia (RBA) rates – the cash rate is likely to be rooted to 2% despite calls to see it lowered. The fact that the RBA itself wants the AUD at around US$0.65 suggests this rate could be lowered. However, the heat that the rate cut could put into the domestic market is a risk too far for the RBA in these current conditions. Plus economic data is showing green shoots and the run in the AUD after the Australian GDP figures is evidence enough that the bear call around the Australian economy may have been overdone.
There is now a fourth variable that is turning the long call even more bullish and creating a thunderstorm: China’s economic targets released at the National People’s Conference will back stop Chinese growth and will back stop against a possible hard landing which adds to the positive pressure on the AUD.
Key points for the AUD
- GDP has become China’s ‘whatever it takes’ line – a 6.5% to be defending the baseline is a lot of infrastructure spending. China will not take its foot off the growth accelerator.
- M2 money supply growth is set at about 13%. They’re increasing the debt ceiling to a record level and will continue to pump money in even if growth remains sluggish – ie, stimulus.
- Interest rates to ‘maintain appropriate levels from 2016 to 2020’ – lowering them is the most like scenario to ‘maintain appropriate levels’.
- Budget deficit raised to 3% of GDP. Expectations are it will rise to 4% of GDP.
The AUD has added over 8.5% against the GBP, EUR and JPY and we therefore see some upcoming weakness in the AUD as profit is locked in and the carry trade slows. We see this as a good chance to look for long positions.
Today’s China trade balance may be one such scenario. The figures (as expected) were terrible. Its February trade surplus of US$32.59 billion was 36% below estimates as exports collapsed down to 25.4% year-on-year. Chinese Lunar New Year always skews the February numbers; however, the figure is much lower than expected and such a big miss has created some angst.
The effect against the AUD during the Asian session was strong, with the three currencies EUR, GBP and JPY being the biggest gainers versus the AUD on the back of the trade balance release.
We actually want to see weakness here as it gives us a better position for our long call. We understand the risk in the AUD; however, with the European Central Bank likely to cut rates on Thursday and the Fed likely to hold off next week, risk currencies will benefit. The fact that China is now looking to stimulate over the coming months and years means the perfect storm in the AUD is going to become a thunderstorm.