ANZ: Short the Australian dollar

Via ANZ:

As was the case late last year when the AUD looked excessively weak, we do not think that the current state of affairs is sustainable.

There are two elements that are concerning us.

First, the AUD is currently at an extreme in term of its correlation to commodities, beta and the DXY, all of which have pointed to strength. If this correlation declines and rates — which are signalling weakness — once again become more important, then the AUD will likely fall.

Second, should these strong correlations manage to hold, we see risks that, at least on a tactical basis, there is scope for commodities to ease, for risk sentiment to sour and for the USD to once again find its feet as the recent strength/weakness in all these factors is at a historical extreme.

The AUD has traded more closely with the broad commodity complex than with commodity prices which most closely proxy Australia’s terms of trade.

This highlights that actually the recent strength in the AUD has been more about the decline in the USD, and the general global reflation trade, rather than it being a result of a re-rating of the prospects for the Australian terms of trade.

This leaves the AUD vulnerable.

The decoupling of the USD from the recent move in rates is now at an extreme and a re-coupling should be broadly positive for the USD, which is also looking technically very oversold.

Risk appetite — which is a key input into our USD model and a historic driver of the AUD — is also looking very stretched.

…Looking at the list of traditional drivers of the AUD, they are either signalling that it should be a lot lower — in the case of rates — or that its trajectory is at risk of turning.

While we are not yet ready to say that the AUD is standing at the precipice of an extended decline or a test of its cycle lows, we certainly think that relative to December 2017 — when the AUD was trading at around 75 cents — the risk/reward equation has shifted drastically.

With the AUD now trading within 1 cent of our forecast peak, we favour using this strength to reset shorts.