Australian dollar crosses show real strength

The last time I wrote about the Australian Dollar it was July 5th and the Australian Dollar was at roughly 1.03 and the  title of the piece was the Australian Dollar is overvalued. Since then the Aussie has traded down to 1.01 and now sits at 1.0363 as I write and “fair value” is still in the mid-90 region.

In the grand scheme of things, and in “model” time, the intervening price action is really just noise. A couple of cents on the Aussie is a bit of fun. But as Emma Lawson from NAB was quoted saying in the previous post:

Looking ahead, the slower global growth data is likely to be the centre of attention near term, taking the stage from the immediate EU issues. The AUD is likely to remain beholden to this global sentiment. Positioning is lightly short in the AUD, and the AUD is relatively expensive compared to model estimates and recent history. This biases the AUD lower, but does not preclude a spike higher on global liquidity injections. We would see any spike as a sell opportunity.

And that is exactly what is happening to the Aussie at the moment – the thrill of the chase for more liquidity injections is buoying markets and pushing the Aussie higher.

But in truth, those peddling the bearish case must admit its more than  just that. The Australian economy’s out-performance is also reinforcing the positives for the Aussie, as is the RBA rhetoric suggesting that rates aren’t going to be cut again anytime soon.

So the AUD/USD is marginally higher than earlier this month but it is against the crosses where its recent run has been spectacular and which shows that at the margin the Aussie is supporting itself, not just QE or USD.

The performancce of the Aussie crosses is something that is super important to note for traders and investors who want to negate the impact of the USD, which is a primary driver of FX markets.

If you want to do that then you play the crosses. You won’t eliminate the US Dollar completely but you can mitigate its inflauence where the different outlook for other countries shines through. So AUD/NZD is an Australia versus Kiwi outlook and unlike the rugby one we normally do OK at. EUR/AUD is Eurozone v Australia plus a risk play, GBP/AUD  is the UK economy and interest rates versus Australian ones. And AUD/CAD is pitting the two big G10 developed commodity economies against each other.

As you can see in the following charts each of these crosses has risen strongly recently reflecting the fact that much of the Aussie’s strength is home grown.

EUR/AUD – new all time low and a cracking trade we instituted at Macro Investor and a trade which is 700 pips in the money at present. But with the Euro trying to base against the USD and this one looking severely oversold with a reversal is in the offing. Still, where would you rather have your money at the moment?

GBP/AUD – you might wonder why I refer to EUR/AUD and GBP/AUD in this way and not the the reverse like the AUD/USD. It is because this is how the big traders look at them and so for that reason I’ll reverse normal convention of quoting other currencies in terms of Aussie.

After rallying strongly against the Aussie, Sterling has been under intense pressure as the UK economy has faltered and as the BoE has launched more QE and programs to save the economy. The fall in inflation is possibly headed toward deflation in the UK over the next 12 months so a further drop might be in the offing toward the recent low at 1.4540 which is coming into view again.

AUD/NZD – trapped in a wedge formation but the Aussie has been doing well against its water based cousin recently. Probably a bit toppish at present though.

AUD/CAD – looked like it had topped until the Aussie’s recent strength against the USD re-emerged. Australia currently has a stronger economy and outlook (not saying it’s right or wrong just reflecting what FX markets are saying) and so this one might have further to go.

That the Australian Dollar’s strength is showing against all of these crosses tells me that the markets still think there is relative value in being long Aussie Dollars versus a host of other currencies. At the end of the day that is what currency trading is all about – every trade or investment you place is a relative one – one outlook versus another rather than a single factor analysis. That’s what makes FX so much fun, but equally so hard.

For the moment the Australian dollar is well supported in and of itself – so I’d say that there is marginal Aussie strength over and above the fairly sanguine outlook that equities are taking on the future and thus other risk assets as well. Talk of QE3 and monetary stimulus will keep it thus and actual quantitative easing might just drive it much higher still.

Twitter: Greg McKenna. He is the Chief Investment Officer of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

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Comments

  1. I’ve noticed that unless US data comes in at expectations, the AUD/USD always ends up surging. Bad = QE, and Good = Risk On. Both lead the USD down. The Australian economy being surprisingly strong for now is a factor but it is mostly the levitation caused by almost daily speculation of imminent QE3.

    It’s actually pretty bad as too much trading is happening based on hopes for stimulus, bailouts and QE none of which actually fix anything.

    Do you see the AUD reaching 1.75 again? Based on my simple observation of what drives it up, it seems resistance levels are the only real factor controlling a change in direction :S

    Last time Italy was struggling with high yields we went deep below parity. This time both Italy and Spain are struggling and we are shooting for the moon?