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FxWirePro: A Glance at Driving Forces of Aussie and Relative Value Trades
FX markets were in a risk-averse mood, concerned the US-China trade negotiations may have stalled.
Australian 3yr government bond-yields fell from 0.73% to 0.71%, 10yr yields between 1.09% to 1.05% (a one-month low). Markets are pricing a 25% chance of easing at the Dec RBA meeting, and a terminal rate of 0.46% (RBA cash rate currently at 0.75%).
The supply interruptions could limit the recent fall in iron ore prices, coal prices remain near 3-year lows and we expect the US and China to reach only a very limited trade agreement in coming weeks. The Antipodeans are exposed to China, locally, both AUD and NZD sit in the midst of an ongoing central bank easing cycle, while growth and inflation outcomes are still trending soft. Over the medium term, these should be exacerbated by ongoing external dynamics from moderating China growth, trade war spill-over and poor historical performance during Fed easing cycles. Each are also subject to important structural adjustments taking place over the medium- term.
Moreover, the RBA does not want to encourage an A$ revival and pricing for another rate cut has been unwound too far, as we still expect a rate cut in Feb 2020.
The underperformer Aussie dollar against Japanese yen fell from 75.673 to the current 73.785 levels, we could foresee further downtrend in the days to come.
While AUDNZD retains downside momentum, next target 1.0540.
AUDNZD, in the medium perspective, multi-month, we target 1.10, with fair value much higher at 1.12 (AUDNZD’s extreme undervaluation may be explained by the global trade wars which have hurt the AUD more than the NZD).
Contemplating above factors, buy a 3m/1m AUDJPY put spread (74.500/72.007) (spot ref: 73.785 level); sell a 3m 1.1075 AUDNZD put (spot ref: 1.0584).
Alternatively, as we could foresee further downtrend of AUDJPY in the months to come, on hedging grounds we advocate shorting futures contracts of mid-month tenors as the underlying spot FX likely to target southwards below 70.500 levels in the medium run. Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position (spot reference: 73.785 level). Courtesy: Westpac