SHORT AUDUSD TP 800PIPS: BREXIT, RBA, FED & USDJPY HEDGEShort AUDUSD is in my top 3 FX Trades for several reasons:
1. AUD is considered a riskier G10 currency cross, so AUD trades weaker in risk-off markets, or when equities/ SPX trade lower (you can see the high correlation with SPX at the bottom of the graph).
- With Brexit concurring last week, global risk has increased, this is especially the case for AUD due to commonwealth connections. Therefore AUD is likely to come under pressure in the future as risk-off sentiment continues to dominate, as the US Election nears, Global growth worries continue (Japan, Europe, China) and Brexit/ uncertainty about further Euro Area exits continues to intensify - we can see Gold and US Treasuries continue to gain supporting the risk-off view and thus supporting selling AUD. Also, risk-off encourages $ buying as a safe haven deposit on the Brexit backdrop.
- Further, going into earnings season next week, historically risk currencies (AUD) perform poorly as investors seek safer assets to hedge against earning surprises, thus this helps AUD selling and USD buying. Plus, most investors will want to hold some $ cash in order to fulfil their earnings based equity trading, so this also helps the short AU trade by increasing $ demand relative to AUD.
2. The RBA Meeting on Tuesday the 5th is likely to be dovish, as 1) Brexit risks are weighed in on again, after supportive/ dovish statements from RBA members following the Brexit decision and 2) AUD Macro Environment has performed poorly since the last meeting and the May Rate cut e.g. Retail sales 0.2% vs 0.3%, Unemployment flat at 5.7%.
- However, I dont expect an RBA rate cut, as they cut last just 2 months ago in May by 25bps to 1.75% and their GDP print was firm at 3.1% v 2.8% yoy and 1.1% v 0.8% with Unemployment also stable (yet to see inflation), so I expect them to provide reassurance to markets with a strong dovish tone, with possible hints to a August rate cut - citing Brexit and looking forward to their end of July Inflation print as a gauge for further rate cuts. Nonetheless the dovish rhetoric should be strong enough to put pressure on AUD and tip the scales south supporting the AU short.
3. From a USD demand point of view, last week we saw USD lose 160pips against the AUD as Brexit Uncertainty negatively hit the Feds Rate hike cycle expectancy, flattening the curve in the front end which ruled out any hikes until Dec or 2017, fewer hikes = less USD strength.
- However, since the beginning of the week where brexit risks ruled out hikes in the near term, the end of the week managed to turn rate hike expectations around as Brexit likelihood decreased/ shifted into 2017. This helped the Fed fund futures curve recover/ steepen somewhat in the front end, with the implied probability of a hike increasing from 0% to 5.9% for both September and November, whilst the probability of a hike in December also steepened significantly from 13.3% to 22.3% with the probability of a 50bps hike being priced for the first time at 1.1%. This trend of Fed Hike recovery is likely to continue as long as Brexit risks remain subdued, so we can expect USD to begin to price stronger in the coming days/ weeks.
4. Technically, AUDUSD trades 100pips away from a key handle at 0.76xx which is a double top and may provide the ideal short area. Further, higher than that at 0.78xx is the 12 month high which is also potentially a great level to get short from as a double top
5. Volatility - 1wk, 2wk and 1m (-1.52, -1.57, -1.60) AUDUSD Risk Reversals all trade with a downside bias indicating put/ downside demand is higher than upside, so the option market net expects AUDUSD to come down over the above tenors.
- Out through the 5th, 6th, and 7th (post RBA) we see large notional OTM put options and open interest at 0.7365, 0.7440 & 0.7445 which supports the view that the RBA will be dovish and that AUDUSD is likely to hairpin around the 0.76xx double top level.
