FxWirePro: Commodity prices to signify Aussie dollar on edginess – Stay hedged on mounting OTC activities via optionality to arrest bearish risks in H2’2017

Coal prices have spiked in the aftermath of Cyclone Debbie, but any price rise should be temporary. Severe supply disruptions following floods in Queensland (refer above chart) have pushed up the price of seaborne coking coal.

Our analysts believe that the impact of this cyclone is likely to be less than that seen in 2011, and believe supply should normalize quickly, so have not made any upgrades to their forecasts.

At the same time, iron ore has turned. There is clear downside risk to many analysts’ forecasts for iron ore prices, which assume an USD75/t target for 4Q17. Steel production and prices in China have weakened considerably (refer above chart), and the PPI reflation theme is fading fast as monetary tightening has intensified.

It has also been a weaker period for iron ore supply, with shipments from Australian ports tracking weak through 1Q, which will be a headwind to the March quarter GDP result. So while the terms of trade will rise again in 1Q/2Q on the lagged effect of earlier commodity gains, the more contemporary news-flow is more downbeat.

Consequently, AUDUSD is testing the bottom of the USD0.72USD0.78 range that has held since mid-2016. The upside for the currency is indeed capped by the prospect of further narrowing in short rate spreads and a sense that the Australian economy is not performing as strongly as policy makers would like, with retail spending and the labor market particularly worrisome. A move below USD0.72 in the near term, however, seems to require further escalation of commodity weakness and a sense that the RBA has sufficient flexibility on the housing front to ease soon.

These leave the A$ with strong resistance at around 0.75-76 levels. We expect to see it heading towards 0.74 by year end.

While delta risk reversal reveals divulge more interests in hedging activities for downside risks. As a result, we can understand ATM puts have been costlier where the spot FX market direction of this pair is heading towards 0.73-74 or below technical levels. So, the speculators and hedgers for bearish risks are advised to optimally utilize the upswings and bid on 1-3m risks reversals that would encompass Fed’s June meeting. While we advocate staying short in mid-month futures on hedging grounds as more slumps are on the cards in the weeks to come.