Australian dollar dislocates from greenback amid dirt frenzy

See the latest Australian dollar analysis here:

Will Bitcoin destroy the US dollar?

The Australian dollar has been rising very quickly in the past few weeks. This is as expected. My target is the low- to mid-80s. The drivers are obvious in very high terms of trade and a declining US dollar. How are these two playing out together?

First, a Wall St take on the US Dollar Index (DXY) via Societe Generale:

The Fed Chairman makes a strong case for the merits of allowing the US economy to run hot and temporary price hikes due to the pandemic to be ignored, if a broader labour market improvementis going to be achieved. He’s on much less solid ground if he thinks that rates this low doesn’t destabilise asset prices, but that’s for another day. He took some of the heat out of the bond market which may trigger the next round of dollar weakness?

The challenges facing EUR/USD are familiar. For now we define the range we’re in as 1.2020-1.2220, and won’t get excited until we break free. The only way that’s going to happen is with the help of broad-based gains by other currencies to drag the euro up despite the position logjam. So far this month, of a list of 31 currencies, the euro ranks 21st, one place above the dollar. The g10 laggards are the yen and Swiss franc, the g10 winners are AUD, GBP, NZD, CAD, NOK and SEK. The euro is also lagging PLN, CZK, and RUB. It’s likely to go onlaggingEuropean peers but may be able to break out of the top of its range if they are dragged along by Mr Powell’sdovishnessandglobal economic optimism. Concerns about possible fresh lockdowns in Europe and about slow vaccination rates, can just about be overlooked along with the positioning.

The G10 currencies which ought to benefit most easily from a very dovish Fed are still the ones sensitive to real estate-AUD, NZD and CAD. AUD is the most fashionable but also the one when RSIs are stretched. CAD is the least fashionable but the one which would benefit most from a short-term spike in oil prices. Meanwhile, the g10 currency which is surprising me the most, is sterling. Not because I never expected GBP/USD to get here–ourforecastslook for it to spend heret of the year in a 1.40-1.50 range–but because I don’t really understand why it’s so fashionable right now.

As I’ve noted many times, markets have a huge short in place on the US dollar which is making it difficult for it to break lower:

But Australian dollar positioning is still short so it has room to run higher:

We are now beginning to see this play out in the currency pair. While the US dollar hasn’t fallen in 10 weeks, the Australian dollar has marched higher regardless, up 3.5 cents over the same period.

This is quite unusual so it’s worth charting the pair in index form:

Such charts are always held hostage by the starting point but the 1983 float seems a reasonable place to begin. As you can see, the AUD is currently pushing away from the corresponding value of DXY. The divergence is already approaching the highs of previous commodity booms with the exception of the China supercycle:

Presently, the terms of trade do justify this move even if the level of DXY does not:

The question is, how far can it run? I don’t think that DXY is going anywhere near the lows of the pre- and post-GFC periods. That was during a historic US-centric bust.

Indeed, I am no longer confident that the US dollar will fall much further given the second half of the year is going to see the US outperform Europe and the world in growth, yields and inflation. Add a fading China and falling CNY and it’s even more difficult to see.

But we still have six months for DXY to fall so let’s say it drops another 5% drop by then. That would get us to AUD 0.835 on the Aussie.

So, to get higher than that we’ll need to see further AUD divergence from DXY which will largely hang on iron ore.

For iron ore I expect goods prices to continue in the first half with a goodly seasonal drop in May so the average price will probably be around where it is today overall.

Therefore, with another, say, 1.5% divergence from the falling DXY we’d get to 85 cents AUD by mid-year.

That would give AUD the third-largest DXY divergence on record:

My best guess for the peak as things stand.

David Llewellyn-Smith
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Comments

  1. US bonds sales are literally failing while the Senate just finalized the $2 Trillion money printing bonanza – nope, cant see any reason for a decline in the dollar, nope.

    US $2 Trillion package focuses on bailouts for bankrupt councils, cities, states, counties, rental, housing assistance, $1400 bonus, money for vaccines, school reopenings etc – There is nothing at all that I can see of any economic benefit outside a cash injection primarily to state level organizations and a small bonus for the poorest Americans. $50 Billion to Universities, $400 Billion to various business entities etc – its largesse on an absolutely massive scale – compare that to China

    $500 Billion stimulus last year –

    internet data centres

    new energy vehicle charging stations

    5G networks

    industrial internet;

    inter-city transportation and inner-city rail systems;

    artificial intelligence; and

    ultra-high voltage.

    That is absolutely massive and is exactly what nation building is. The US is in serious, SERIOUS trouble.

    • I think Biden will try and build infrastructure, and encourage US private industry to build the above things as well – they already are…that’s where a fair chunk of the hot money is going…

    • pfh007.comMEMBER

      Stewart,

      You are right on the money. It does not take long to see the huge differences in how ‘stimulus’ is allocated between countries that have some notion of productive investment and countries in the west who think that driving debt into asset prices is a smart idea.

      The Chinese are clearly wasting their time building all that useful kit.

      They would be much better off driving up the prices of financial assets or driving consumption …….like we do.

      But then the Chinese are not burden by a host of parasites at the centre of their public monetary system gorging themselves on the advantages of having a monopoly on transactions in central bank deposits.

        • pfh007.comMEMBER

          Considering the creepy and secretive nature of the CCP it is remarkable that they do not have a major resource mis allocation problem.

          Beyond the somewhat mythical and probably limited ghost city issue they seem to be pretty good at continuing to build stuff that is useful and required …….quickly and at reasonable cost.

          According to staff, wages in cities like Shanghai are getting close to the point that they are competitive with many parts of Australia.

          We simply cannot afford to keep misallocating our boom time income and convince ourselves that China is as foolish as we are.

          • The Traveling Wilbur

            Howard did it.
            Gillard did it.
            Abbott did it.
            Turnedlessblueballs did it.
            Scomo’s doing it.
            Even an educated flea would do it.

            Worked so far, right?

      • It’s funny how the Chinese are following the ‘American System’ and are called into question by the Americans. The Yanks are now following the ‘British System’ and don’t even know it. I reckon if you were able to ask the Founding Fathers who won the Revolution, they wouldn’t even know there had been one.

  2. “[sterling] I don’t really understand why it’s so fashionable right now.” The pound is behaving like a tech stock – rocketing up and then down yesterday. Maybe it’s because of the vaccination success or a nostalgic view that it’s a petro-currency (with oil rising). It can’t be because of Brexit – nobody thinks that’s working.