Straya T’day – 12/9/2014

History rhymes for valiant AUD

Despite its well-earned moniker, something finally stuck to the ‘teflon’ Aussie dollar and it’s been absolutely creamed this week, with interesting parallels to the early stages of last year’s rout.

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The staggering jobs figure yesterday didn’t provide an iota of support for the AUDUSD beyond the hour or so after the data hit the wires. In fact, the impact was just the opposite, with the pair ruthlessly sold later in the day. Something very similar happened in May 2013.

As in the past few months, the AUDUSD traded in a well-defined range up to May last year. The 1.0200 level was a widely recognised line in the sand; this year .9200 was the key support. The primary source of demand for AUD-denominated assets in each case was the attractive interest rate differential between Australia and other major economies (known as the ‘carry trade’). Carry trades can be lucrative for as long as a currency is stable or appreciating, however an aggressive reversal can erase profits in a very short space of time. This fact actually makes reversals more likely to be aggressive, since long positions profiting from carry are always on high alert for a change in the trend and thus prone to stampeding for the exits.

The RBA began hacking away at the interest rate differential in late 2011, however there was little reaction in the exchange rate, in part owing to the still-wide gap between local and foreign interest rates, but also because of the announced return of QE by the Fed in September 2012. The Aussie battled on.

As has been the case this year, there was no shortage of bearish sentiment in the lead-up to May 2013, the rationale for which was outlined in this perfectly timed piece from the Macro Man blog. The terms of trade had clearly peaked, the sharp drop in LNG mining investment over the following few years was being recognised, and the unemployment rate was trending higher.

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Signs that the RBA was likely to continue chopping at the cash rate began weighing on the Aussie early in 2013, pushing it to the lower bound of the range, but 1.0200 held nonetheless.

Then whispers of a scaling back of the Fed’s bond buying program began to seep out. One of the first manifestations of this concern was in gold, which was simply massacred, falling close to 20% in a month.

gold

The Aussie dollar wasn’t far behind. Following a soft CPI reading in late August, the RBA cut the cash rate on May 7, dragging the AUDUSD beneath critical support at 1.0200. This year it was renewed vitality in the USD, especially against the yen, that drove the initial move in the AUDUSD below support, but coincidentally, in both instances a stomping seasonally-adjusted jobs figure briefly resuscitated the pair just after the initial break (the 2013 figure was later revised down, no doubt a similar revision will transpire for the 2014 one).

2013
AUDhistory1

2014
AUD3

In both cases, the failure to re-establish support after the bullish data release was about as bearish a signal as you’ll see, and acted as the catalyst for the subsequent collapse. Longs still committed prior to the jobs report were forced to accept reality when a wave of selling arrived above the previous support levels, and folded shortly thereafter.

It’s hard to say exactly what the magnitude of the drop will be for the AUDUSD now, since so much is riding on the words and actions of the Fed. The taper of QE was announced by Bernanke in late May, and the associated plunge in US bonds was a major reason for the severity of the decline in the AUDUSD (that is to say, USD strength played a significant role).

Therefore, as is so often the case in our modern markets, we await the Fed for a sense of how big this AUDUSD selloff will be. It’s fair to say that the spike in US yields won’t be as pronounced as the first ‘taper tantrum’, so that may well limit the speed of the move. But few would look at the AUDUSD chart tonight without seeing the infirmity written all over.

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