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Of late, Aussie dollar (AUD) has benefited considerably from the global risk bounce, as well as the local economy’s relatively rapid emergence from government shutdowns. To the extent that global equities and commodity prices have run ahead of fundamentals, AUD will be exposed to any pullback as there are numerous idiosyncratic headwinds to consider too.
Most fundamentally for a small and isolated open economy, the cost of ensuring better health outcomes is likely to be medium-term damage to the traditional growth model (particularly population growth, and services exports) which will see cyclical outcomes come back to the global pack over time. As with many other economies, we are wary of the fact that the fiscal policy impulse is likely to wane in 2H. Australia will probably see greater impact than most, given that government welfare programs have had a clear role beyond just income support, in capping the measured unemployment rate. A growing geopolitical spat with China, and risk of ongoing negative headlines and possible export quotas/restrictions also gives reason to suspect AUD could trade cheap relative to its model fair. On the more positive side, insulating factors are the terms of trade, and (relatedly) fiscal policy. The terms of trade are of course linked to the vigour of China’s industrial recovery, but significant supply disruptions in Brazilian iron ore limit the downside to Australia’s most significant goods export.
The revival in global equities has been a key contributor to AUD’s rebound to the 0.68-0.70 area, with the positive correlation with risk appetite firmly intact. The Aussie’s support is broader than equities however, with iron ore above $100/tonne on both supply and demand trends, helping Australia maintain a current account surplus for a full year. Australia’s outperformance on Covid-19 containment also raises the prospect of a sharper domestic economic rebound which keeps the RBA comfortable with current policy settings.
The end-Q3 projection is at around 0.70 levels, but with lingering pressure on the Aussie (sub-0.66) over Q3 & Q4 is likely from a patchy global economy and woeful earnings reports, along with mounting geopolitical apprehensions.
Trade tips: Contemplating all these fundamental factors, we advocated some relative value (RVs) & hedging strategies using FX derivatives contracts.
Buy AUDJPY vs AUDUSD 2Y ATM straddle spread.
Buy AUDUSD 3M ATM vs sell 1M 25D AUD put/USD call, 100:150 notional ratio, delta-hedged.
Alternatively, contemplating major downtrend, on hedging grounds we recommend shorting AUDUSD of next-month month futures (August’2020 deliveries) as the underlying spot FX likely to target southwards (at around 0.6650 levels) in the medium run. The writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: JPM
