Australian Dollar: USD/AUD (AUD=X) further escalation in trade tensions could keep the downside risk elevated

Australian Dollar: USD/AUD (AUD=X) further escalation in trade tensions could keep the downside risk elevated

Australian Dollar: USD/AUD (AUD=X) further escalation in trade tensions could keep the downside risk elevated

Looking at the past six months of FX movements (Fig. 1), the Australian dollar has acted as the most accurate proxy for China-related sentiment (especially on trade tensions), as demonstrated by the highest correlation with the Chinese yuan. The reasons for this relationship are not transitory and suggest the two currencies will keep moving in tandem.

First, Australia is more dependent on exports to China than any other economy in the G10 space. The looming slowdown in Chinese demand has quickly become a serious threat to the Australian economy. Second, the trade tensions (which have been the primary driver of Chinese market sentiment) are having a significant impact on global risk aversion, and a risk-sensitive currency such as the AUD is inevitably impacted. Third, the same trade turmoil has pressured commodity prices, some of which comprise a sizable portion of Australian exports.

Fig.1 – AUD is the most exposed to global and China-related sentiment

The RBA may be done for the rest of the year

The Reserve Bank of Australia lowered the cash rate twice this year, in June and July, before pausing in the August and September meetings. At the same time, the Bank has reiterated its openness to “ease monetary policy further if needed” to support growth and achieve its inflation target.

Additional easing may appear to be warranted given that inflation is currently at 1.6% year-on-year and far from the 2-3% target band. However, there has been some improvement from 1Q when CPI was at 1.3%, and inflation expectations have rebounded of late. Also, rate cuts seem to have halted the rise in the unemployment rate, which remains at 5.2%, and the August jobs report showed solid growth in full-time hiring. On top of that, recent GDP data (0.5% quarter-on-quarter in 2Q) endorsed the view that the economy is in relatively good shape.

All these reasons have led our economics team to write off any additional rate cut in 2019 and we are now expecting only one cut in 2020 (Fig. 2).

Fig. 2 – We are less dovish than market expectations on the RBA

Trade wars should get worse

The latest news on the trade front has been well received by risk assets, especially as China and the US are now ready to hold another round of negotiations in October. More recently, the announcement that China has exempted some tariffs on US exports has further supported hopes for a respite in the conflict. However, as noted by our China economist, the exemption should be seen as an attempt to support China’s economy rather than as a concession to the US.

This fits into our house view which holds that trade tensions will actually escalate further in the coming months and that a US-China trade deal by the end of the year no longer seems like a realistic possibility. In fact, despite the recent positive news flow, the two sides still appear to be far apart on some key points – above all, on intellectual property, where the Chinese are unlikely to make large concessions. What’s more, President Trump seems to be in no rush to reduce pressure on China just yet (equity markets and the economy are holding up relatively well) and he may not make a decisive move towards a trade deal before an economic slowdown becomes apparent. 

Short-term downside remains warranted

We expect the medium-term outlook for the Aussie dollar to be dominated by two conflicting forces: escalating trade tensions and a less dovish than expected RBA. Of these, we believe the first driver will prevail. Hence, we believe the balance of risks for AUD/USD remains tilted to the downside and an extended pause by the RBA (hence, a more supportive rate outlook) should play out only as a mitigating factor.

Accordingly, we see AUD/USD dropping to 0.67 in the coming months, before starting to recover at the beginning of 2020. A year from now, we expect the relatively solid economic fundamentals in Australia and abating risk sentiment to push the pair towards 0.72.

Technical Indicators

Overall, the bias in prices is: Sideways.

The projected upper bound is: 0.69.

The projected lower bound is: 0.68.

The projected closing price is: 0.69.

Candlesticks

A black body occurred (because prices closed lower than they opened).
During the past 10 bars, there have been 7 white candles and 3 black candles for a net of 4 white candles. During the past 50 bars, there have been 20 white candles and 30 black candles for a net of 10 black candles.

A spinning top occurred (a spinning top is a candle with a small real body). Spinning tops identify a session in which there is little price action (as defined by the difference between the open and the close). During a rally or near new highs, a spinning top can be a sign that prices are losing momentum and the bulls may be in trouble.

Momentum Indicators

Momentum is a general term used to describe the speed at which prices move over a given time period. Generally, changes in momentum tend to lead to changes in prices. This expert shows the current values of four popular momentum indicators.

Stochastic Oscillator

One method of interpreting the Stochastic Oscillator is looking for overbought areas (above 80) and oversold areas (below 20). The Stochastic Oscillator is 78.4512. This is not an overbought or oversold reading. The last signal was a sell 0 period(s) ago.

Relative Strength Index (RSI)

The RSI shows overbought (above 70) and oversold (below 30) areas. The current value of the RSI is 59.70. This is not a topping or bottoming area. A buy or sell signal is generated when the RSI moves out of an overbought/oversold area. The last signal was a buy 25 period(s) ago.

Commodity Channel Index (CCI)

The CCI shows overbought (above 100) and oversold (below -100) areas. The current value of the CCI is 94. This is not a topping or bottoming area. The last signal was a sell 0 period(s) ago.

MACD

The Moving Average Convergence/Divergence indicator (MACD) gives signals when it crosses its 9 period signal line. The last signal was a buy 19 period(s) ago.

Rex Takasugi – TD Profile

FOREX AUD= closed down -0.000 at 0.686. Volume was 99% below average (consolidating) and Bollinger Bands were 7% narrower than normal.

Open     High      Low     Close     Volume___
0.686 0.686 0.686 0.686 808
Technical Outlook 
Short Term: Overbought
Intermediate Term: Bullish
Long Term: Bearish
Moving Averages: 10-period     50-period     200-period
Close: 0.68 0.69 0.70
Volatility: 6 8 9
Volume: 63,452 66,152 89,762

Short-term traders should pay closer attention to buy/sell arrows while intermediate/long-term traders should place greater emphasis on the Bullish or Bearish trend reflected in the lower ribbon.

Summary

FOREX AUD= is currently 2.2% below its 200-period moving average and is in an upward trend. Volatility is extremely low when compared to the average volatility over the last 10 periods. There is a good possibility that there will be an increase in volatility along with sharp price fluctuations in the near future. Our volume indicators reflect volume flowing into and out of AUD= at a relatively equal pace (neutral). Our trend forecasting oscillators are currently bullish on AUD= and have had this outlook for the last 4 periods.

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