FxWirePro: Bearish/Bullish Driving Forces, Projections Of AUD/USD, OTC Updates And Hedging Strategies Ahead Of RBA

Bearish AUDUSD scenarios below 0.64 if: 

1) the RBA cuts rates more quickly than we expect; 

2) Fed rate cuts prove insufficient to stabilize the US economy raising risk of recession; 

3) the trade conflict between the US and China escalates again and broadens.

Bullish AUDUSD scenarios above 0.70 if: 

1) China eases policy more forcefully and commodities rally on the back of future infrastructure spend; 

2) the Australian government commits to large fiscal easing, shoring up growth prospects and reducing the need for a further easing from the RBA in coming months. 

We carry the bearish projections of AUD at USD 0.65 at mid-year, and 0.64 levels by the end of 2020. Tailwinds are from the global cycle, and to an extent, commodities, which are holding up the fair value estimate and offsetting some drag from persistently negative rate spreads. Still, we expect the domestic economy to fall short of the RBA’s goals this year, driving a further 50bp of easing, further widening rate differentials vs USD. 

The AUD, as a proxy for global risk sentiment, will continue to be buffeted by coronavirus concerns, with a dip below 0.67 likely. Beyond that, RBA is scheduled for their monetary policy next week, we expect growth will be seen as slowing and labour market strength will unravel, causing the RBA to cut the cash rate to 0.50% and again in August to 0.25%, after which AUD is expected to revisit 0.66. 

Later in the year, with the RBA approaching the effective lower bound, we expect the central bank to announce a QE package. This would provide further downside for AUD, but we do not expect this to be pre-emptively priced in spot FX given: 

1) the RBA will probably be late in acknowledging this scenario, and 

2) much of the effect of QE is likely to come via the delivery of the excess liquidity itself into the overnight cash market.

OTC Outlook of AUDUSD and Options Strategic Framework: 

The positively skewed IVs of 3m tenors are also in line with the above predictions, they still signify the hedgers’ interests to bid OTM put strikes up to 0.6450 levels (refer 1st nutshell).

Please also be noted that we see fresh bids for current bearish risk reversals (RRs) setup across all the longer tenors are also in sync with the bearish scenarios (refer 2nd (RR) nutshell).

In a nutshell, AUD OTC hedgers’ sentiments substantiate that their risk mitigating activities for the further downside potential has been clear. 

Accordingly, diagonal put spreads are advocated to mitigate the downside risks with a reduced cost of trading.

The combination of AUDUSD’s short-term potential to hit 0.70 and fails from there onwards amid lower IVs is luring for the OTM put options writers. While the medium-term perspective is attractive for bearish hedges via ITM puts.

The execution of options strategy: At spot reference: 0.6687 level, short 2w (1%) OTM put option with positive theta (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, add long in 2 lots of delta long in 3m (1%) ITM -0.79 delta put options. 

We keep reiterating that the deep in the money put option with a very strong delta will move in tandem with the underlying. Courtesy: Sentry, JPM and Saxobank

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