Trade idea - Stay short AUD, -3% to 0.73 by end-Dec within reach
Tuesday, November 21, 2017
AUD - Strategic short vs USD, target 0.73 by end-Dec (-3.3% vs 0.7550 as of 21 Nov-17)
AUD carry advantage over the USD is diminishing. The 2yr ACGB-UST spread has fallen to 2bp and the 1yr forward RBA rate spread over the Fed turned negative in 1H-Nov (current: -7bp). Negative carry may deepen further if the market pushes back current consensus expectations for a 2H18 rate hike. Cyclical slowdown (particularly in retails/consumption) amid weak wage/CPI growth may reinforce RBA communication that it is in no urgency to tighten with other global central banks. Commodity price weakness and an unfavourable outcome for the Turnbull govt in the Sydney Bennelong elections would add further tailwind. Risks to view: Retail sales surprisingly recover (5 Dec), US GOP fiscal/tax reform push falters, US FY18 budget/debt ceiling is messier than anticipated.
Fundamentals (modest negative):
Economic (modest negative): Real economy data have been trending weaker (vs prior and consensus). Retail sales (1.4% yoy, Sep-17) have decelerated from highs in Q2 (3.7%, May-17) to its lowest since 2013. Consumption comprises 55% of the economy and this has been weighed by stretched household balance sheets (higher mortgage loans amid higher lending rates, peaking property prices) and weak wage growth (no passthrough as yet from a relatively tight job market). Non-mining investment has been picking up.
Economic data has been surprising weaker vs expectations - with the Citi Economic Surprise Index flipping to negative in Oct and extending further in the negative (-34 as of 21 Nov-17 vs 1yr high of +62 in Jun-17).
Policy (modest negative): RBA reluctance to signal tightening - given weak-domestic demand concerns, still-absent wage/inflation pressures and unwanted appreciation pressure on the AUD - places downside risks to market expectations for a hike in 2H18. Economists forecast one rate hike by end-2018 (Bloomberg survey, as of 21 Nov-17) while OIS markets are pricing-in 52% and 78% probability of a rate hike by the 4 Sep-2018/4 Dec-2018 MPCs, respectively (as of 21 Nov-17).
Politics (modest negative): The 16 Dec-17 special election in the Sydney district of Bennelong triggered by the 13 November resignation of the sitting member, John Alexander of the Liberal Party - at best - distracts from the Turnbull administration's fiscal reform agenda and - at worst - could lose the govt its 1-seat parliamentary majority. A recent poll (20 Nov-17) shows Alexander - who has since renounced his UK citizenship - running neck and neck vs Labor Party. [Gnews: "bennelong 2017 election"]
Valuations (slight negative): Given the AUD's traditional carry allure, much has been commented about the nearly linear positive relationship between AUD and the US-Australia rate spreads (R-squared 0.89 in daily AUD vs 2yr ACGB-UST spreads since AUD peak on 8 Sep-17). A re-pricing of the rates trajectory for the Fed (higher) or RBA (lower) could add further tailwind to a weaker AUD; a 5yr regression suggests AUD downside towards 0.75-0.65 (R-squared 0.75).
AUD is moderately cheap vs the ANZ China-weighted basket of commodities (R-squared 0.74, weekly, 10-year history).
AUD is cheap-to-fair versus 5/10yr average REER/NEER.
Technicals (negative): AUD remains among the most favoured FX majors based on CFTC positioning (+44k net long, as of 21 Nov-17) even after declining since its recent peak (+77.2k on 26 Sep-17). Economist and strategist near-term forecasts have been skewed lower.