Established in 1974
185,800 clients worldwide
Over 15,000 markets

AUD flying high

The theme over the last 12 hours has been lower volatility, and traders and investors have been wondering whether we are in for a prolonged period of low volatility.

AUD
Source: Bloomberg

Looking at the US volatility index (the VIX), we can see implied volatility in the S&P 500 has fallen 4.6% to 16.88, however this is still in line with the 12-month average. The ASX volatility index has also pulled back in the last few days to 20, but again, this is still hovering around the 12-month average and at a 17% premium to the five-year average.

AUD – The perfect storm

One just has to look at the price action in the S&P 500 last night, where we saw the index trade in an 18-point range, while the Dow traded in a lowly 134-point range. Low volatility and positively trending equity markets (the S&P 500 closed on the day’s high) means hunting for yield and being paid to be in a position. That was seen clearly in the Aussie banks yesterday. With such bullish price action front and centre in the FX markets, the AUD is now looking strong. AUD/USD has drifted to the $0.7300 area, but the real action is in the crosses where EUR/AUD and AUD/JPY are moving far more aggressively on a risk-adjusted basis. Investors can pick up a 1.85% yield in an Australian two-year bond relative to a negative 55 basis point yield in the German bund and a negative yield out to 10 years in Japan, which naturally favours the AUD. In fact, when you adjust bonds for inflation, one can still get a positive ‘real’ return in Australia if we push the maturity curve further out. The greatest risk for the AUD may be renewed CNY weakness.

There are not many economies who are in this situation so in times of lower volatility, reach for the AUD. If the Reserve Bank of Australia (RBA) ever really wanted to get the AUD down, they would need to flatten the yield curve aggressively. This simply isn’t going to happen!

Australian January trade data is released at 11:30 AEDT. Expectations are for a modest improvement in the trade deficit (consensus –A$3.2 billion), although I suspect the AUD won’t be hugely sensitive to the print.

When we consider the ongoing rates hold at the RBA and another 2% rally in the iron ore price overnight, you then have the perfect recipe for AUD appreciation. Take a look at the daily chart of high grade copper as well, which often leads the Aussie. The bulls are fully in control of this move; the trend is certainly your friend and goes hand-in-hand with the steeping of the fixed income curve in Australia and the US – ie the world is not such a bad place.

The ASX 200 to test recent highs again

The ASX 200 will naturally feed off the US lead, but should be supported given the underlying strength – our call is for 5040. Japanese markets will likely open modestly lower, so if we see traders looking to support this index from the initial fall, it could support S&P futures, which in turn should be beneficial for Australian equities. I do feel that moves to 5055 on the ASX 200 will be faded should we get there today, as the trend is still sideways and conditions dictate that two standard deviations from the 20-day moving average could result in mean reversion. A close above the 23 February high of 5037 would be positive though.

Oil has been fairly whippy, but the net effect is a modestly higher price with US oil currently trading at the top end of its multi-month range. Sizeable conflicting forces were at hand with a sizeable 10.37 million barrels increase to inventories (reported by the EIA), relative to a strong 6 million decline in production. Exxon reducing output is certainly aiding this bid in oil. Aussie oil plays should do nicely on open, while BHP should open 3% higher based off its ADR’s performance.

China will be a key focus and many will be preparing for this weekend’s National People’s Congress. Traders, economists and investors will be primarily focused on the GDP target for 2016, where talk has been that they will set a 6.5% to 7% growth target. Today’s CNY ‘fix’ could be a focal point and will get more attention with the market devoid of a strong lead. In the US, we’ll also get jobless claims, factory orders, durable goods, but the highlight will be services ISM (expected at 53.1). After a strong ADP payrolls report last night (214,000) keep an eye on the employment sub-component as this is the best lead for Friday’s payrolls report (consensus 195,000).

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication.