Conclusion: While some factors remain supportive, our interpretation of and outlook for key fundamentals are indicating further downside in the AUD/USD exchange rate over the intermediate term.
Position: Short the Australian dollar (FXA); Long the U.S. dollar (UUP).
This morning in our Virtual Portfolio Keith re-shorted our favorite way to play our compendium of active Global Macro themes within the Asian FX landscape – the Aussie dollar. We’ve been making this call since 2Q throughout a collection of research notes (hyperlinked below) and the AUD has generally underperformed other Asia-Pacific currencies vs. King Dollar throughout various durations within the last six months. To recap, our bearish thesis is fivefold:
- Slower Growth domestically and in key export markets (Asia accounts for ~70% of Australian exports) will weigh on expectations for tighter monetary policy and potentially degrade fiscal metrics. Domestic manufacturing, services, and labor market activity all remain extremely subdued;
- A Deflating of the Inflation in Australia’s reported inflation and inflation expectations (both market-based and central bank targets) will lead the RBA to incrementally ease monetary policy and erode Australia’s real yield advantage relative to the U.S.;
- A Deflating of the Inflation across Australia’s key exports (commodities account for ~60%) will reduce Australia’s terms of trade and coincide with a pullback in international demand for Australian exports and, hence, the Aussie dollar;
- Domestic Housing Headwinds (all-time low mortgage demand perpetuating falling prices) will act as a long-term drag on economic activity and consumer confidence; and
- A potential Correlation Crash and Liquidity Risk are two key quantitative and behavior factors that could weigh on the Aussie dollar in the event of a USD-breakout. The AUD/USD rate continues to trade with a positive correlation to the S&P 500 with an r² north of 0.90 on both our immediate-term TRADE and long-term TAIL durations. Additionally, the AUD is the best-performing currency vs. the USD since the Mar ’09 bottom (nearly +60%) and mean reversion remains a risk if underperforming FX investors turn to the Aussie dollar as a potential source of liquidity (see: chart of gold).
On a supportive note, Australia’s solid fiscal positioning (debt/GDP < 30%; deficit/GDP < 5%), a continued drive towards achieving a balanced budget over the medium term, and the sovereign’s AAA status will continue to keep a bid for the Aussie dollar – especially in an environment of elevated sovereign debt risk. That said, however, we expect the marginal buyer/seller of Aussie dollars to continue demanding lower price points for the currency as our interpretation of and outlook for key fundamentals are indicating further downside in the AUD/USD exchange rate over the intermediate term.
Related research notes covering each of the five aforementioned factors in greater detail:
- 4/6: Aussie Dollar – Getting Long in the Tooth
- 5/19: Aussie Dollar – Dancing ‘til the Music Stops
- 7/27: We Wouldn’t Want to Be Glenn Stevens Right About Now
- 10/11: Shorting the Aussie Dollar
- 11/21: Covering the Aussie Dollar – We’ll Be Back
- 12/9: Weekly Asia Risk Monitor – Mind the TRENDs Across Asia