AUD/USD is now eyeing a move to 65c by year end

There is an interesting dynamic at play today, with oil continuing to find huge upside price action and inflation expectations further stabilising at a time when a number of G10 central banks meet.

Source: Bloomberg

One of those is the Reserve Bank of Australia (RBA), who meet today, and will be enthused by a 5% increase in iron ore since the prior meeting. At the same time, the AUD has fallen 1% on a trade-weighted basis and 2.5% against the greenback. The biggest declines have come against the EUR as traders unwound carry trade positions, amid increased volatility. The RBA will be fairly happy with those dynamics, although domestic data hasn’t been overly inspiring and their concern for emerging markets, specifically China, could somewhat increase. Of course, any view around the timing of the Federal Reserve hikes will be monitored closely, because at a very simplistic level, there is a view that the longer the Federal Reserve hold off, the greater the chances of further easing from the Reserve Bank.

The European Central Bank (ECB) meet later this week and while we shouldn’t hear of an immediate increase to its asset purchase program, there is a strong view that they will open the door to either additional purchases or an extension to the program. Either way, quantitative easing programs are never announced in isolation and as we have seen from the Fed and Bank of Japan (BoJ), the first move is never usually the last move. I think EUR/USD trades will lower this week, but feel that easy money will be made going into Thursday’s meeting, as traders anticipate dovish rhetoric from Mario Draghi.

Back to Asia, and we should see an extension of yesterday’s losses in the equity market, although how Chinese markets fare is anyone’s guess. If there is a focus on stabilising markets, then the news flow that traders had to navigate through yesterday only confused matters. On one hand, we heard suggestions that the authorities were looking to pull out of buying equities directly in the market, with a view to focus on the root of how the market was being destabilised. On the other, we heard speculation that the regulatory commission was working with a number of top-tier brokerages to provide RMB100 billion to a rescue fund – again, to stabilise the market.

The constant here is a stable market ahead of the 3 September World War II commemorations, but how they go about achieving this is not immediately apparent.

Our opening call on the ASX 200 is for a move into 5174, for a loss of 0.6%. The interesting dynamic will be strong gains seen in the resource space being offset by weakness in stocks who source a larger percentage of sales domestically. BHP’s American Depository Receipts (ADR) are indicating an open 2.7% higher, which suggests good gains in the space if we use that as a proxy. With WTI oil up 8% from Monday’s cash close, it doesn’t take a genius to see that we’re going to have good outperformance from energy stocks. If the sector carried more weight on the overall market then we would see a positive open for the broader index.

Also on the docket are Aussie Q2 balance of payments (BoP), which should see the wider deficit (consensus AUD$15.9 billion) and net exports subtracting 30 basis points from Q2 GDP (announced Wednesday). I suspect there is downside to the 0.4% quarter-on-quarter consensus growth print, but this belief will be firmed after the BoP data is released at 11.30am AEST. Building approvals will also be released, but will not carry as much weight.

Prior to local data, China will release its August manufacturing PMI data at 11.00am, with expectations of the index highlighting a below 50 reading (and therefore contraction). We get a revision to the disappointing Caixin reading 45 minutes later, so all-in-all expect the AUD and China related assets to see whippy price action between 10.45am to 3.00pm AEST.

It’s worthy of note that that AUD/USD closed the month below the 2001 uptrend, and this is certainly fuel to those who feel the pair can trade into $0.6500 this year. Fundamentally, while we have seen Australia’s key export stabilise and the RBA remove its view that further currency weakness is no longer necessary, we are seeing dynamics in the bond market suppress the AUD/USD from rallying. With the US two-year treasury looking to make another crack at breaking the 75 basis point (BP) ceiling, the yield discount seen relative to the Australian two-year government bond has contracted to the lowest level since 2006, at 104 BPs. The lower the premium, the less compelling it is to hold AUDs (over USDs). If this trend continues, then traders will look to sell AUD/USD.

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