We have a market. That is we have now heard from the bullish camp on the AUD with Glenn Mumford’s article in today’s AFR representing quite a bullish outlook for the AUD which he reckons is going to 1.10 pretty soon.
I’m expecting the local dollar to trend towards $1.10 over coming weeks…This next leg of Australian-dollar strength will to some degree reflect the relative support likely as energy and industrial metal prices continue to trend higher. IT has certainly been a factor over the past year, as the $A lived up to its “commodity currency” tag.
But I think the shift against the US dollar will be the most pronounced, given that I’m expecting a fresh wave of Us dollar selling to emerge this week.
So it’s maybe less about the AUD and more about the USD. That’s entirely reasonable because the USD is the other side of the AUD/USD rate. Let’s look at what he reckons will happen to the USD and see if that stacks up for the AUD.
Mumford’s arguments about the impending fall in the USD feel like they may be technically based even though he gives fundamentals to support them. Indeed he highlights the divergent goals of the ECB and the Fed and the impact this may have on the value of the EUR/USD rate which reckons is headed toward 1.50. In this regard, the differences, he’s right. The Fed is happy to leave policy where it is even if inflation rises, Bernanke said as much last night up on Capitol Hill while the ECB, still seeming haunted by the Weimar Republic has an itchy trigger finger all ready to jack up interest rates. Now, interest rates have an outsized impact on perceptions of and moves in currencies sometimes and this is particularly the case when rates are as low as they are in both Europe and the United States at present.
But his argument about the absence of a run to the Greenback (USD) last week proving that the end is nigh for the only viable reserve currency on the planet slices way too thin I think:
We got an idea of just how weak the outlook for the US dollar had become last week as investors squared off risk trades and bought oil in the face of the civil unrest seen across the Middl East and North Africa.
This should have delivered a classic safe haven “buy the greenback” outcome, but in the end it failed to elicit any meaningful investor response.
A run to the USD is often not a run to a safe haven but a run out of risky trades. Ergo there must be large volumes of risky trades which need to be unwound in order to generate an observable effect.
I’d argue that increasingly over the past few years with all the volatility and increase in computing power that markets around the globe are increasingly driven by short term traders. These types of traders are aggressive and fast but they don’t tend to build big positions and hold them for long periods of time necessitating exits when things go awry. So while I have no way of proving my hypothesis on this from where I sit, last week’s price action could simply be a result of a lack of conviction and fear of volatility in an increasingly uncertain world. Thus there was no observable exits of risky trades or run back to the unit, or currency (USD), of account.
The reason we think this could be the case is that our favourite currency bellwether of risk, AUD/CHF, has been lagging for some time. Let’s look at this pair versus the S&P 500 and say that we think they summarise global risk appetite.
To reiterate. The S&P is the global bellwether of the reflation trade and the AUD/CHF represents China, Commodities, Punting and the Swiss safe haven. AUD/CHF should rise and fall with global risk appetite. The swissy is a classic old style safe harbour.
What we see in the chart however is that from the equity low in March 2009 this relationship was solid up until very late last year when the AUD/CHF started to lose its lustre. This suggests perhaps that traders in this and other markets had changed their view on risk even before the Middle East eruption.
To me that suggests that there may not have been as much “risk” on the table last week as might have been the case 4, 5 or 6 months ago and that this meant less position squaring back to the USD. That’s the hypothesis anyway.
Oh, and you could rightly say “but didn’t you write that AUD traders were long AUD last week as a reason it might fall?”. The answer is yes, absolutely and I still think AUD is vulnerable in an uncertain world but the China dividend seems to outweigh everything at present.
Now back to Mumford. Let’s say he is right and the USD does weaken against the EUR is it really going to push the AUD sharply higher? Perhaps not materially, unless the USD absolutely crashes. Look at the chart below which maps the AUD/USD rate versus the US Dollar Index (inverted) we don’t need a correlation table to show this relationship is not as strong as it has been in the past. Clearly this is because the China and Commodity story in the minds of AUD/USD traders than is the impact of moves of the USD on its own.
So, while a weaker USD will help at the margin it may not push the AUD/USD as high as Mumford thinks.