I haven’t posted on the AUD this week largely because nothing is happening as it trades within the recent range. Certainly the downside looks more protected than its did for the past few weeks but I’ve been watching it all week wondering why it is so weak?
You’re probably wondering how I can say that as it sits back at 1.07 and change against the USD this morning but I reckon with the USD on the backfoot again and with Moody’s wondering aloud about the United States Sovereign and Bank ratings it should be stronger. Back over 1.08 at least. Perhaps we’ll see that tonight after non-farm payrolls but rather I think that perhaps Houses and Holes is right about the looming Commodity pullback/crash which is building and thus acting as a handbrake on the AUD.
If Australia is this new miracle economy which has been rerated by all and sundry with Central Bankers and investors diversifyinig into holding our assets then how else can you explain the AUD/USD price action or even less the AUD/EUR price action unless the weakening outlook in US and European growth is sapping the AUD’s strength.
Lets look at the AUD/EUR first.
What you see here is a cross that has clearly broken down below the old trend line from the lows of 2009 which has then retested it but not been able to break back above. But, the bit I’m interested in is the last few days, the red bars at the right, where AUD has underperformed EUR.
The only rational explanation for this is that markets are rerating growth and the AUD/USD long (that is owning Aussie Dollars and selling US or other currencies) is probably a crowded trade. The question is how can we tell if this hypothesis has any credibility in a market where the VIX Index (Chicago board Options Exchange volatility index for the S&P 500) has not moved materially and is well below march highs.
One of the things I look at is the AUD/CHF (Swiss Franc) rate to see if it is telling me anything about the approach to risk as I think there is still a lingering belief in currency markets that this trade is both sides of the risk coin. Like all bilateral trades there is a myriad of influences but I always like to watch this one as the AUD is the worlds favourite punt and the CHF the worlds safest haven.
But I want to take this analysis, and Houses and Holes’, one step further to see if my idea that the fingers of instability in the global economy and markets are growing is true. Clearly we can see that the economy globally is weakening which threatens everything. But equally worrying would be if the old habit of leverage was back in vogue.
Unfortunately we heard from Fed Vice Chair Janet Yellen yesterday in Tokyo that leverage is back and worse still in the hands of proverbial babes. Yellen noted,
signs of valuation pressures in some markets and a moderate increase in leverage provided by dealers
On the scaryness, to me at least, of who is holding the leverage she noted
…two dynamics with respect to the use of leverage bear watching. First, important classes of generally unlevered investors (for example, pension funds) are reportedly finding it difficult in the present low interest rate environment to meet nominal return targets and may be reaching for yield by assuming greater interest-rate and credit risk in their portfolios. While some investors have also apparently boosted returns by increasing leverage, we see little evidence at present that this behavior is occurring on any significant scale. Second, additional funding is reportedly broadly available to traditionally levered investors such as hedge funds. To the extent that investors choose to take advantage of the readily available funding for less liquid assets, their use of leverage could rise quickly, increasing the risks of a disorderly deleveraging.
Yellen may not be worried but I am. Neophytes taking on leverage because they can’t get the return they need to hold their FUM scares me and increases global risk of a reversal and rush for the exits.
I think it helps explain why the AUD has been relatively weak. Too many people are already in the trade and probably leveraged.