The last time I wrote about AUD/USD, we stressed that many of the traditional cross asset links had blown up. Meanwhile, the AUD/USD has switched from a commodity/carry trade pair to a classical currency, a change that would not be uninvited in a country that is undergoing a major economic transition.
The spread between the short end of swap curves in both the US and Australia used to be a good indicator but, as can be seen on the left chart below, the gap has widened considerably between the implied level of 1.08 and the current reading. Not only has the relationship weakened in the medium run, but a short run focus suggests that the link remains very poor. The link between AUD/USD and the swap curve spread may in fact have disappeared.
A relationship that has not disappeared and shows no apparent mispricing for the AUD/USD is the real rates spread. Real rates combine long nominal rates and (market based) inflation expectations. US tapering threat combined with a smother monetary policy in Australia can explain the move. But tighter real rates may also suggest reduction in relative real growth rate expectations, something undoubtedly linked to the doubts that arose about the Australian economy's long run model.
The long run chart of 1-month risk reversals for the AUD/USD is another example of a structural break from the pre-2013 era. Yet I favor using risk reversals on a tactical, short run basis. I do not see any significant disconnect here (right hand chart).
In the classical risk on/off era, the AUD/USD and the S&P 500 would have moved together. It looks like following the late-2012 disconnect, the pair is struggling to recouple. It is clearly too soon to tell whether the old pattern will prevail again, even if the last 90 days have been "encouraging."
Could it be the case that the AUD/USD is acting like a commodity currency once again? As can be seen in the chart below, there seems to be a timid realignment taking place between AUD/USD and copper moves, but I'm not entirely convinced. In addition given the poor prospects for copper in the next couple of years, the recoupling would be rather bearish for the pair.
It seems to be that the AUD/USD has a decent correlation with Chinese news flow, which has recently been going up with higher than expected industrial production numbers and solid retail sales and PMI. There is room for some upward potential, as, if the news flow improves, the AUD should strengthen. The chart (below, right) confirms this message.
Technically, the broad picture is rather bearish in the medium run. The AUD/USD has stabilized in the recent weeks but the outlook remains bearish below a resistance at 0.9420 (former medium term support now resistance). A failure to clear this resistance would trigger a new bearish wave toward the recent low. A break above 0.9420 would instead trigger a larger rebound toward 0.97, possibly 0.9965. The long-term trend remains bearish below this resistance.
From the above we know that:
1. Money market curves spreads are no longer reliable. This is particularly striking as the sharp fall in the AUD/USD was partly triggered by the easing stance adopted by the RBA.
2. The risk on/off usual suspects no longer matter as much as they used to: the S&P 500 and copper prices no longer track the AUD/USD. There have been some tentative signs of recoupling recently, but I would not bet on them.
3.China's driving force has tracked the weekly changes in AUD/USD, but in absolute terms the distance between China's news flow and the AUD/USD is too wide to be true.
4. For understandable reasons risk reversals still track short-term moves of the AUD/USD but they currently suggest no mispricing. And ...
5. The main driver is currently the long term real interest rates spread. It can be linked to the fact that real interest rates are a proxy of long term expectations for real GDP growth. Based on consensus forecasts for US and Australian long term yields and CPI, the trend for the next six months remains slightly on the downside, in accordance with the medium run message sent by technical analysis.