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As seen in the chart, we saw a huge move overnight, partially driven by a poor US consumer confidence report, but it was certainly a USD move and traders simply needed a vehicle to express their weak USD view against.One would usually reach out to the NZD, but the market feels the RBNZ will be fairly dovish tomorrow morning (07:00 AEST), so look at the CAD and more so AUD.
With low volatility traders want carry and it’s almost as if we are going back a few years where the USD was the key note funding currency! The pair is right on key horizontal resistance, so it is interesting to see the initial rejection. A break here would be very bullish indeed.
It seems the dominant force has been bond yield spread and I have specifically looked at the premium the Aussie 10-year bond commands over the US 10-year treasury. As the premium (in favour of Australia) has increased from 38 basis points to currently stand at 60 bp the AUD/USD has followed. The moves in iron ore are probably helping the Australian government bond attract sellers (yields up). Although, if we look at the swaps market we haven’t really seen an all-out collapse in near-term rate cut expectations. We have seen a pricing out of longer term cuts, but the market still expects a 50% chance of a May cut.
If we summarise the conditions behind the recent move, the question now turns to whether we have got to a point where the AUD/USD moves back above fundamental value in the RBA’s eyes. One suspects if this was purely a weak USD story then the RBA would really look to talk down the unit, but the moves higher become less bad when you see iron ore rallying so strongly.
- Low volatilty appealing to carry trades
- A widening of spreads (for now)
- China expanding its balance sheet, offering loans to commercial banks to assist in the efficiencies around the RMB1 trillion debt swap for local governments. Some have labelled this QE, but that is a misconception
- A modest liquidation of what was a very stretched USD position
- A 27% upside move in spot iron ore in 16 sessions!
- Oil prices helping stabilise inflation expectations
- A view that we may get a reluctant cut from the Reserve Bank in May, but that will be the end of the easing cycle for now