Remaining constructive on AUD

In contrast to the consensus view I remain rather constructive on the AUD. As reflected in the RBA minutes today the central bank has shifted its stance somewhat, effectively closing the door on further policy easing while finding it difficult to talk the currency lower as inflation pushes higher.

Separately although Chinese growing is slowing this year assuming that growth does not fall too far and too quickly the AUD is unlikely to suffer much from this source.

A lot bad news for AUD has been largely priced in. Firstly, the drop in AUD/USD has been consistent with the deterioration in terms of trade.

Secondly Australia’s broad basic balance position is quite healthy as strong direct investment and portfolio inflows counter a current account deficit.

Thirdly, even when looking at China’s growth trajectory the AUD is at a level which discounts this. Near term resistance for AUD/USD is seen around 0.9087.

AUDTOT

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AUD hit by weak jobs data

AUD has been one of the best performing major currencies so far in February. Better than expected Chinese trade data released yesterday was a boon for the AUD given Australia’s strong trade links with China. Moreover, as markets have backed away from RBA policy easing expectations AUD has gained a sound footing.

Positive sentiment for the AUD was dashed today however, following the release of January jobs data which came in worse than expected at -3.7k versus +15k consensus. The details were weak too, with the unemployment rate rising to a 10 year high of 6% and participation rate dropping to 64.5%.

The data will clearly restrain AUD in the short term, but is unlikely to spark renewed risks of further policy easing given a rise in inflation pressures. In this respect, AUD is set to continue to show some resilience over coming weeks. Near term AUD/USD support is seen around 0.8915.

AUDjobs

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Australian dollar rallies, Korean won bounces back

On the currency front, the best performers so far this year have been an odd combination of JPY, NZD and AUD versus USD. JPY has benefitted from both compressed yield differentials with the US and risk aversion but its gains are likely to reverse over the coming weeks as these factors reverse.

I have been generally more constructive on AUD and NZD than the consensus and remain so. Both AUD and NZD look oversold and will gradually appreciate further, especially as both the RBA and RBNZ have now likely ended their easing cycles, with the latter set to raise policy rates by the end of this quarter. AUD/USD breached 0.90 this morning helped by a strong business confidence reading for January.

Most Asian currencies have rebounded so far this month, with some of the biggest losers over January recording gains. The KRW has been the best performer in February recording gains despite continued outflows of equity capital. Korea has recorded $1.26 billion in equity outflows so far this month, the highest among Asian countries.

In contrast bond inflows into Korea have been relatively solid over January and this continued into February, helping to provide some support to KRW despite equity outflows. Helping the KRW is the fact that is much less sensitive to US bond yields than many other Asian currencies helping it to avoid any fallout from higher US yields in February. USD/KRW is on path for a break below support around 1070.

AUD rallies on firm data

Australian retail sales rose 0.5% in December in line with expectations although the ex inflation quarterly increase was lower than forecast at 0.9%. However, there was a revision higher to the previous quarter. The bigger news is that the December trade balance came in much better than expected, recording a surplus of AUD 468 million compared to a deficit of AUD 200 million expected. Business confidence also came in strong rising to 8 in Q4 from an upwardly revised reading of 5 in Q3. The data bodes well for AUD, with the currency set to find further support in the short term. If anything, it also helps to validate the RBA’s message that the easing cycle is over. A break above AUD/USD 0.90 is now on the cards.

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RBA statement bullish for AUD

AUDIMM

AUD has held up relatively well considering the pressure on risk currencies in general. The fact that speculative positioning in AUD has already fallen to extreme levels suggests 1) scope for further downside is limited and 2) AUD could bounce strongly in the event of good news.

In the event, the RBA unsurprisingly left policy rates unchanged but focussed attention on the recent rise in inflation. The RBA highlighted in its accompanying statement that inflation has been higher than forecast. Moreover, the RBA does not appear to be actively talking the AUD down but highlighting the benefits of past AUD weakness if sustained.

Overall, the statement is bullish for the AUD especially as it appears to confirm that the policy easing cycle is over. Consequently the bounce in AUD following the rate decision is likely to be strong.

AUD/USD technical support is seen around 0.8660, with resistance at 0.8889.

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Some respite for emerging market assets

Large gains in many emerging market currencies have been registered in the wake of policy rate hikes in Turkey and to a lesser extent in India. Also some encouraging data in Asia in particular a widening in South Korea’s current account surplus helped to shore up confidence in regional currencies. Not wanting to throw cold water on the move but while everyone is lauding Turkey for its bold move the reality is that its aggressive rate hike will hit growth at a time when its economy is fragile.

The massive rate hike in Turkey (repo rate hiked from 4.5% to 10%) fuelled a bounce in risk appetite nonetheless, although most risk measures have only reversed part of the move registered over recent days. It is way too early to suggest that everything is returning back to normal and the rally in risk assets looks vulnerable to fading out over coming days.

While I am not a proponent of the nervousness in emerging markets turning into a renewed crisis, uncertainty about country specific issues such as slowing growth and deleveraging in China, fundamental and political uncertainties / elections in Thailand, India, Indonesia. Ukraine and countries in the “fragile 5” against the background of Fed tapering, suggest rocky times ahead.

Moreover, the market may have priced in another $10 billion of Fed tapering today but the reality is that the global liquidity injections provided by the Fed will be reduced over coming months. Additionally a likely renewed rise in US Treasury yields will add another layer of pressure on emerging market assets.

Although emerging market currencies have strengthened most G10 currencies remain in a tight range. G10 FX gains were led by the AUD and NZD while JPY came under renewed pressure. This pattern is likely to continue in the near term. Aside from the Fed FOMC there will be some attention on the Reserve Bank of New Zealand too. The RBNZ is expected to keep policy rates unchanged but there is a small chance of rate hike or at the least a hawkish accompanying statement which ought to keep the NZD supported.

AUD oversold, GBP running into resistance

AUD/USD has faced a significant bout of pressure since testing a high of around 0.9087. A dismal jobs report in December piled on more pressure on the currency and since then it has failed to recover. Consequently short speculative positioning has increased as sentiment has deteriorated. Yesterday’s slate of Chinese data failed to dent the AUD however, with the currency encouragingly showing some resilience.

Attention will now turn to tomorrow’s CPI inflation data. The release of the TD Securities inflation gauge which printed higher than consensus, highlights upside risks to the release of Q4 CPI and in this respect I believe market expectations of any RBA policy rate cuts look overdone. My quantitative model estimate for AUD/USD suggests that the currency is oversold, with short term fair value seen at around 0.9226.

GBP/USD is edging back up to its year highs around 1.6526 recorded at the turn of the year, a level that is likely to prove to be a tough resistance level. In spite of softer data including manufacturing and service sector confidence readings as well as industrial production the currency was buoyed by a strong December retail sales report at the end of last week.

Jobs data and the Bank of England MPC minutes will be on tap on Wednesday providing more direction for the currency. The minutes are likely to reveal few surprises but there is no doubt that the Bank is moving towards some sort of change in language on its forward guidance. GBP will find little further support over coming days, with consolidation likely. However, market positioning does not appear to be particularly stretched, suggesting limited downside risks.

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