Potential AUD/USD trade

The AUD has been sold of late on the idea that the Chinese economy could be in trouble, while the Fed could alter its stance and potentially give a clearer signal about when short-term rates could rise.

Australia
Source: Bloomberg

This view has been most evident in the sell-off in the US bond market, with yields across the curve moving higher.  The question now is, has the market become too optimistic on when the Federal Reserve raise short-term rates?

Firstly I would answer this by arguing that the moves higher in US yields (resulting in USD strength) have been justified given the improving data in the US. However, it seems logical that to see a further sell-off in the US bond market we will need to see the Fed alter its language in today’s FOMC meeting (04:00 AEST).

The big issue is whether Janet Yellen and co remove the central bank’s stance that interest rates will rise a ‘considerable time’ after bond buying finishes in October. If they do remove this stance then it is effectively code to say expect higher short-term rates in either Q1 or Q2. John Hilsenrath (of the Wall Street Journal), one of the most respected journalists, wrote in a column in US trade that the Fed would stick with the ‘considerable time’ line, which caused some selling of USDs, keeping AUD/USD supported.

We shall watch the event intently as the ramifications around Fed actions could have large bearings on currencies that have benefited from the easy money policy in the US, like AUD, NZD and CAD.

Looking at price action in US trade, there was a strong spike in the AUD and other assets like copper, A50 futures and gold as speculation (source Sina.com) broke that China was injecting capital into its big five banks. According to reports, the PBoC is offering $81.4 billion through its Standing Lending Facility split evenly between its big five banks. The key here we are seeing an increase in base money, which for all intents and purposes is effectively quantitative easing on a small scale, and has a similar effect as a cut in reserve ratio requirements.

Clearly the market liked the fact that the PBoC is being aggressive and looking to support growth after some poor economic data of late. Still I am hesitant these measures will have a long-lasting effect and thus would fade this move.

Technically AUD/USD just missed the head and shoulders objective of 0.8950 and has rebounded on the actions from the PBoC and the article from John Hilsenrath. Oscillators are coming off very oversold conditions and personally I would be holding off from shorting the pair just yet.

Key resistance comes in at 0.9144 (the 38.2% retracement of the recent sell-off from 0.9402) and this could be a good level in which to potentially work shorts, placing potential stops at 0.9260 (just above the former neckline of the head and shoulders and 61.8% retracement of the mentioned sell-off) for a potential move to 0.8900.

 

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