Commodities Corner: Aussie Ascent Approaches Inflection Point

Aussie Ascent Approaches Inflection Point

As most participants expected the Reserve Bank of Australia left monetary policy unchanged Tuesday. The RBA believe inflation will remain depressed with the economy likely to demonstrate spare capacity in the near to medium term. The RBA’s inflation perspective paves the way for the potential for further easing of policy in order to help shore up domestic demand lag.

Fundamental Flows

With respect to the exchange rate, the RBA restated that the AUD is still in a phase of adjustment as the currency digests the implications of declines in commodity prices. The prospects for an improvement in economic backdrop show fledgling signs of improvement over recent months hence leaving monetary policy unchanged was deemed appropriate for now.

While the fledgling shoots of recovery remain just that, it is highly likely the RBA will move to lower the Official Cash Rate by 25bp in the first quarter of 2016 as economic growth remains below trend rate coupled with an inflation landscape that remains depressed. Although exports were seen as rising and adding to GDP in the third quarter, driven by the weakened domestic currency, the disappointing import data highlights sustained weakness in domestic demand.

Although overall business profitability remained robust in the third quarter challenges remain in the non mining sectors which continue to register weaker readings versus expectations. This disparity is indicative of the uneven nature of the nascent recovery in non mining sectors. The decline in business investment plans will likely have a negative read through into the broader economy over the next couple of quarters.

For the AUD, rate compression remains a bearish force for the currency, but in 2016 it will be driven by Fed hikes rather than material RBA easing.The greatest difference, however, is the terms of trade, which may be bottoming as iron ore prices move within a range and LNG exports rise, thus insulating the trade balance from higher oil prices next year.

Australian commodity exporters are still adjusting to a sharp downturn in commodity prices. Commodity related capex has been cut back and further cuts are expected in 2016. The Austrialina housing/credit bubble limits the scope for consumption-led growth. Non-commodity capex is picking up more slowly than the central bank had anticipated. That leaves net exports as a key hope for growth. Since it peaked in March 2013, trade-weighted AUD has fallen by 21%.

In the first half of 2016, short AUD could also feel the benefit from a weather phenomenon – El Niño. The UN’s World Meteorological Organization has said this year’s El Niño is on track to be among the “worst ever”. A strong El Niño is expected to bring drought to large parts of the Southern hemisphere including Australia and New Zealand which would push up soft commodity prices. But the effect is negative for AUD, as the hit to production outweighs the benefit of higher prices. Meanwhile El Niño is  broadly deemed as growth enhancing for the US, Canada and Europe.

In Australia, the cyclically-adjusted deficit is due to shrink further, as the government aims for a balanced budget (the OECD estimates a cyclically adjusted fiscal balance of -0.8%/GDP in 2015 shrinking to -0.5%/GDP in 2016)

Technical take Away

In the near term, the technicals remain supportive of a further grind higher in the AUD remains positive. The AUD breached the pivotal 0.73 level with last nights in line with expectations Q3 GDP print. As we head into 2016 the case remains that markets may not fully priced in the divergence in monetary policies between Australia and the US next year, and this divergence trade is likely to continue to dominate flows in the pair and while .75 caps corrective upside it would appear that the year to date lows remain vulnerable to a retest and breach.

Trading Take Away

As per the plan posted a few weeks ago in our weekly update, I remain long the AUUUSD near term to trade the correction out lined in the trade plan

The chart below give the market map for the probable path of price, I will as suggested, be closley intraday reversal patterns as we approach the pivotal .7500 inflection point. Where i will upon confirmation reverse my longs and venture short

2015-12-02 12_28_22-

For updates on trade of the day set ups and the other trades I am currently monitoring be sure to follow me on Twitter @LFXPatrick

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