When markets appear to be at an inflection point, opportunities develop. Naturally, traders are encouraged to have a handful of probable scenarios in how the market may react at an inflection point so that a breakdown or failure to realise their favoured outcome does not throw them off course. The Australian Dollar looks to be at an inflection point that should give us an opportunity going forward.
While some traders prefer to look at either the charts or the news, I have found in my trading to look at both. We’ll cover the charts soon, but a key point in the news about the Australian Economy that is grabbing institutional (and therefore, effects what Retail sees) is the diverging yields in the US and AU.
In short, government yields in Australia have fallen relative to the US 10-year counterpart aggressively since September. No worries if you’re not familiar with the pricing of bonds. Basically, higher yields of highly rated debt signify economic confidence while lower yields of highly rated debt signals concern. FX traders will look at yield spreads of countries with similar credit qualities to assess where capital is flowing and where growth is seen.
The widest spread that favoured the AUD-yield over the US 10-year was marked at 61bps in favour of AU Debt to US Debt, and this happened in early September as AUD/USD was trading to $A .81 per USD. Before then, the Aussie had not bought that much USD since late 2015. However, since then, the yield spread has fallen aggressively and recently hit -8.8bp showing a premium for US debt yields. The historic low was in 1998 at -16bps and we could be making our way back there.
Why has this happened and what have been the effects? The main cause is the central banks are forecasting different outlooks for their economy. Currently, the Australian (and New Zealand) central banks are forecasted by the market to potentially increase rates one time over the next twelve months. The markets work in probabilities, and we’re currently seeing over 50% probability of an RBA hike by this time next year. The RBA meets on 6 March, which should cause a relative volatility spike as markets get updated views from the RBA and Governor Lowe later that week.
I tracked the correlation of the AUD/USD spot rate to the AU One-Year Forward Rate, plus a day to find the correlation over the last 20-days. Currently, the regression analysis shows an aggressive +.79 correlation coefficient, which is bound to the upside by +1.00. Therefore, the RBA matters aggressively, and if they continue to pull away from forecasting rate hikes (as they’ve recently done), we could continue to see the yield spread widen in favour of the US and AUD-weakness following suit.
Conversely, the Federal Reserve has forecasted tightening labour markets and a rising neutral rate, which is central banker speak for the rate at which the Fed is neither accommodating or restricting economic growth, and thereby inflation. These seem to speak to a widening relative advantage of USD to AUD.
Looking at the charts: AUD/USD rests on 200-DMA as breakdown could bring bears out