Hi Everyone…first wrap up for a few weeks after my break and after last nights moves looked very much like risk positions were pared with pretty much everything falling. As I write:
- the Dow is down 2.69%, S&P 500 similar amounts, European bourses fell between 3-4%
- the EUR is off 1.67%
- AUD and NZD are down 1.05%
- Crude fell 2.03%
- the CRB is down across the board and
- even Gold is off 0.70%
Add in the fact that the USD index rose with the Swiss franc’s move and it certainly looks like risk is being taken off the table.
That’s not normally a good environment for the Australian dollar and we add in the rumours of imminent Greek default over the weekend and the fact that ECB Board Member (and I think Chief Economist), Juergen Stark, resigned in protest over the ECB’s recent increase in the purchase of periphery bonds, and we see just how fractious things are getting in Europe at both a regulatory and political level.
Indeed Stark told Bloomberg back in the middle of August that these bond purchases blurred the line between monetary and fiscal policy which goes to the core of the issue between the northern Europeans and the Southern Europeans (Club Med) countries. They are not happy with the effective fiscal transfer that the ECB bond purchases amount to. If there is a default, the ECB will lose billions – who will pay the bill? Northern Europe – so yeah, it is more Germany being bailed in than Greece and Spain, and now Italy, being bailed out.
So the market is rightly taking these pieces of European news as highlighting how the risks of a market seizure and or dislocation are growing. The EUR got smashed as a result as you can see below. It is just sitting on the last line of Fibonacci defence at 1.3664 and a break here would see it head back to 1.28. even though EUR is at a 6 month low today that would be my call now and as regular readers know I think the EUR is “worth” no more than 1:1 with the USD so I’m structurally short.
So, there’s a real risk that, if usual patterns hold, the AUD goes substantially lower should this catalysing event occur.
Lets see how the five drivers tool kit looks then.
Global Growth and Commodity Prices: Growth, not so hot at the moment – PMI’s all over the globe are slipping to or below 50 suggesting that the recovery is slipping back toward economic weakness. This is part of the reason why the AUD hasn’t been able to sustain the higher levels when it has pushed up toward 1.08 again in the past couple of weeks.
But even though commodity prices are lower, as represented by the GSCI chart above and are in a down trend they haven’t crashed. So that has helped AUD hang in better than would normally be the case I reckon.
Domestic growth and Interest rates: clearly the former is weakening and the latter have rallied substantially. This has compressed the spread between Australian 2 year rates and US 2 year rates but this has not had the usual impact on the AUD/USD rate that it has in the past as you can see below.
Risk Appetitie: I think it is fairly clear in the moves in the Swiss franc and in equities volatility recently that risk appetite is lower than it has been in the past. But it hasn’t crashed either. The chart below is the moves in the AUD, CHF, JPY and Gold since August. AUD is certainly not a safe haven but equally it hasnt fallen as far as we might have expected.
Like the relationship with the AUD-US 2 year spread, the AUD has held in well when compared to what you might expect given uptick in people’s view on risk. The chart below is the AUD versus the CBOE S&P 500 Volatility index (VIX) which I have inverted to show what is a relationship that comes and goes but is usually strong when market sentiment deteriorates and the cost of buying protection rises.
Technicals: overnight the AUD has broken an uptrend channel I have been watching all week with the move lower. The level that seems to have held is the 38.2% of the big move from the 0.9928 low back in August which comes in at 1.0445. The low last night according to Bloomberg was 20 pips through but on a weekly close basis it has held.
On the dailies it is a bit more difficult, but I have put the AUD in a downtrend channel and reckon that’s its bias. Interested on others thoughts though. But I’ll run with the levels I get from the hourlies which are that if 1.0445 breaks next week then a move to 1.0345 is next and then a real test of support at 61.2% level of the .9928-1.0765 move which comes in at 1.0248. And remember that 0.9928 is really big support from the fall to 0.80 back in 2010.
USD: The USD is breaking higher against Europe at the moment as discussed above and as represented by the DXY Index chart below.
It is clearly normal that if Europe has its issues that it should weaken against the USD and this would usually see the AUD weaken with it given the relationship between the AUD and the US major Currency TWI – as shown below. I’ve inverted the USTWI price so you can see the relationship but the USD price has yet to be updated for the weekly close but I’d guess it reflects the AUD’s move.
So what does it all tell me?
For the moment the AUD is holding in much better than could normally be expected given the weakening global economic backdrop, given the compression of interest differentials and given the rise in risk aversion. The technicals point down but because the USD hasn’t benefitted greatly yet from the market dislocation, the AUD is holding in well.
So in many ways this is an easy trade. If you think the USD is going to strengthen then AUD has got some downside catching up to do. If not then it can hold up above 1.0240/50 for a while. I think it holds up until Europe breaks – but the risk of that are rising so I like it lower eventually.