Great Graphic: Aussie Approaches Two-Month Uptrend

The Australian dollar recorded a key downside reversal last Friday (July 15) and had seen follow through selling this week.  It is off 1.25% over the past three sessions, which makes it the worst performing major currency behind the Japanese yen.  

As this Great Graphic, composed on Bloomberg shows,  the recent losses have pushed to Australian dollar close to the uptrend line drawn off the late-May low near $0.7150 and the spike low from Brexit (~$0.7300).  The trendline is found near $0.7450 today. 

The $0.7470 area the Aussie tested yesterday and today correspond to a 38.2% retracement of that advance since late-May.  The 100-day moving average is near $0.7485.  The 50% retracement is found a little ahead of $0.7410, and the 61.8% retracement is near $0.7350.   

Short-term speculators may be caught leaning the wrong way.  In the CME futures, speculators have increased their gross long Australian dollar futures position by 40% over the past two reporting weeks to almost 46k contracts, the most in two months.  

Two things are happening.  First, the risk of a rate cut by the Reserve Bank of Australia for next month has increased.  Soft data and the RBA's minutes have encouraged such speculation.  The key is seen to be the Q2 CPI report next week. Confirmation that prices pressures are weak will fan expectation of a cut in August.  In Q1, Australia's CPI  fell 0.2% for a 1.3% year-over-year rate. 

Second, the strength of US economic data and comments from some regional Fed Presidents has investors reassessing the likelihood of a rate hike later this year.   Specifically, the Fed funds have been averaging around 40 bp in recent weeks, which is a bit firmer than through the first half.  There are several reasons for the firmness of Fed funds that are technical in nature rather than as a result of policy, but some of the influences, like the changing of some money market funds, may persist.  The Dec 16 Fed funds futures contract implies an average effective rate of 47.5 bp.  

Given that the December FOMC meeting is on December fair value (average effective rate for the month) is about 52.5 bp.  That means that the December contract is pricing in seven of the 12.5 bp (52.5 bp fair value on a 25 bp Fed hike and the 40 bp that Fed funds are currently averaging and the implied yield on the Dec contract 47.5 bp).  That translates to the market discounting about a 56% chance of a hike at the last meeting of the year. 

The likely divergence of monetary policy and the late market positioning leaves the Australian dollar vulnerable to a greater shake out.   The pullback in gold and copper prices are additional weights on the Aussie.    Technical factors also warn of the risk of further losses if the $0.7450 area yields.

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