AUDUSD: Where to look for buying opportunity?

Summary:

• S&P revises up Australia’s credit outlook in anticipation of the improving budget balance

• General government balance enters a positive territory

• CFTC data suggests there is limited space for further weakening of the AUD

• Iron ore prices have remained stable unlike the Aussie exchange rate

• AUDUSD struggles under the medium-term trend line, where to look for a buying opportunity?

The US dollar has had a successful year so far as it has been the strongest currency in the G10 basket except the Norwegian krone (the NOK has outperformed recently reflecting rising expectations of higher interest rates). In turn, the Swedish krona along with Antipodean currencies have been the worst performing with the former losing over 9%, followed by the AUD (8%) and the NZD (more than 7%). While the economic prospects in New Zealand do not look well and thus the currency could be subject to further weakening, some upbeat signals we have been recently offered from Australia. This analysis focuses on these aspects in outlining the broader outlook for the Australian dollar.

Let us begin with the latest decision of the Standard & Poor's rating agency. The company raised Australia’s credit outlook to stable from negative which was assigned two years ago, the credit rating was reaffirmed at AAA. In a statement the agency signalled it expects that the strong labour market and relatively robust commodity prices lead to steady government revenue growth. The latest budget data is encouraging. The report released last week showed that the overall deficit was 10 billion AUD or 0.6% of GDP meaning a 19.3 billion AUD improvement compared to the original forecast presented before the beginning this fiscal year. Total revenue was 456.3 billion AUD (11.9 billion higher than the first budget estimate) and the amount of revenue generated by taxes accounted for 427.4 billion AUD, 12 billion above the initial projection. Total expenses stood at 460.3 billion AUD, 4 billion lower than indicated, suggesting a greater degree of fiscal discipline. As a consequence, the central government deficit has shrunk recently while the general government balance (both measured as a 4-quarter moving sum divided by GDP) has returned to a positive territory as evidenced by the chart below. If the fiscal discipline stays in place over the next quarters, it should be credit rating positive and thereby acting in favour of the local dollar. Do notice that Australia holds the AAA label from three major agencies while New Zealand holds the highest assessment only from Moody’s as the two other credit rating agencies (S&P and Fitch) keep AA.

The Australian fiscal position has been improving for some time which should be viewed as a positive signal for the Australian dollar. Source: Macrobond, XTB Research

Furthermore, the macroeconomic outlook does look well too with the firm labour market suggesting higher wage growth in the foreseeable future. The strong market has pushed the unemployment rate to a six-year low and is also rapidly absorbing spare capacity - a clear sign that there may be greater traction for wage growth. Nevertheless, price growth has been contained thus far making the current stance of the Reserve Bank of Australia appropriate. In this context we need to take into account that the market-implied probability of any rate hikes in Australia is relatively low with almost no chances to see increases at least until the end of the second quarter of 2019. This along with some upside risks to the inflation outlook implies that market rates could respond quite sharply if the RBA signals a change in bias. Moreover, a next CPI reading will be released at the end of October but a downside risk to the Australian dollar seems to be limited given the fact that the RBA has already flagged that price growth in the third quarter is likely to be weaker due to one-off factors. Having that in mind we also have to take into consideration that the possible weaker print will be partially offset by the weaker AUD as well as higher oil prices. It also needs to be said that unlike New Zealand business conditions in Australia remain solid suggesting not too much worries about business spending going forward. Comparing the two Antipodean economies we also need to distinguish the two different monetary policy stances. RBNZ’s Governor Adrian Orr signals that “our challenge at the moment is to get inflation up, not down” reiterating that the next move could be either up or down (the interest rate market assigns 10% odds for a rate cut till March 2019). In turn, in case of the Australian central bank Governor Philip Lowe sticks to his stance that the next rate move will “be up, not down”.

Speculative positioning signals there is no much free space to see the AUD substantially lower. Source: Bloomberg, XTB Research

Since the beginning of this year the AUDUSD has slid to below 0.71 from above 0.81. This downward move has coincided with a meaningful decline in the net long position held by speculators. In theory, it could limit further downside for the Australian dollar. The net positioning is nearby the levels seen in 2013 and 2015 in both cases the pair saw a bounce then. Although the CFTC data could come in handy in assessing whether there is more space to see either further decrease or increase, one needs to be aware that it does not warrant that the ‘stretched’ positioning cannot become yet more ‘stretched’. Nevertheless, it undoubtedly implies that there are just few speculative investors which could enter the market and thereby exerting further downward pressure on the currency.

Iron ore prices have been surprisingly stable despite risks surrounding a trade war between the US and China as well as slowing growth momentum in the latter. Source: Bloomberg, XTB Research

The last thing we would like to bring up in this analysis concerns in a way the Chinese economy. There is nothing new that the Australian dollar is quite significantly correlated with industrial metal prices such as copper or iron ore. It is due to the fact that Australia is the key exporter of these commodities to China. Therefore, the slower economic growth in China, the worse outlook for the Australian economy and for the Aussie dollar alike. However, as showed at the chart above, there are some periods when this relationship does not work well. For example, even as the AUD has been losing significantly since the start of this year, in part on the back of risks related to slower growth in China, we have not seen the same story in case of iron ore prices. Moreover, although copper prices have moved down initially they have recovered recently but the improvement did not buoy the AUD. Assuming that there is not too much free space left for the deeper pullback in the AUDUSD, and also assuming that the relationship between the AUD and iron ore prices will be restored, one may anticipate that the pair could see at least a corrective increase.

Technically the AUDUSD is trading below the bearish trend line and one may expect that it may find it hard to move higher unless the trend line is broken out. Therefore, we recommend to place a buy stop order at 0.7300 with a take profit at 0.7650 and a stop loss at 0.7140. Source: xStation5