UK based guest contributor, Patrick Reid takes on a bearish view of the AUD/USD and provides three key index levels to watch
It has been a torrid week for AUD/USD.
Just as yields collapsed, the recent data out of China was far from cheerful. On top of that it appears that the China credit tightening is finally taking a toll on data – in this sense, AUD/USD remains a strong proxy for Chinese economic and financial risk.
On that note, China credit growth data and weaker than expected activity was an unwanted fly in the existing bowl of rotten Australian cherries.
There, I’ve said it.
The “hawkish” hike from The FOMC had little effect, but AUD/USD didn’t need much encouragement to weaken further. In short, the outlook is not looking great and risks are firmly to the downside.
USD funding and the recent LIBOR-OIS blow out didn’t put a bid under USD as such, but I would argue AUD funding has been hit the most with BBSW-OIS spreads, which have widened far more than its counterparts.
Adding to the pain is the AUD FRA/OIS picture - which at best looks softer, however still elevated. Be aware.
In Figure 1, we clearly have broken key support at the .7500 area and closed below. There is clear water until .7160 and if DXY breaks 95, and commodities soften, I see us getting there within three months.
Key levels to watch for my bearish view to remain intact:
- Staying below .7500
- DXY breaking 95
- First target .7330
AUD/USD daily – Oct 2015 to May 2018
Source: Bloomberg, FIIG Securities
DXY - The U.S. Dollar Index (USDX, DXY, DX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the U.S. dollar gains "strength" (value) when compared to other currencies.
FOMC – Federal Open Market Committee
FRA -OIS – Market expectations for LIBOR - OIS.
LIBOR – LIBOR is the London Interbank Offered Rate, an interest rate at which banks can borrow money from each other. The rate changes daily.
LIBOR-OIS – A decade ago, most traders didn’t pay much attention to the difference between two important interest rates, the London Interbank Offered Rate (LIBOR) and the Overnight Indexed Swap (OIS) rate. That’s because, until 2008, the gap, or “spread,” between the two was minimal.
But when LIBOR briefly skyrocketed in relation to OIS during the financial crisis beginning in 2007, the financial sector took note. Today, the LIBOR-OIS spread is considered a key measure of credit risk within the banking sector. [Source: Investopedia]
OIS – An overnight index swap is an interest rate swap involving the overnight rate being exchanged for a fixed interest rate. An overnight index swap uses an overnight rate index, such as the overnight federal funds rate, as the underlying rate for its floating leg, while the fixed leg would be set at an assumed rate.
About Patrick Reid
Patrick Reid co founded Adamis Principle to educate and mentor FX traders at all levels. He and co founder, Adam Gazzoli have both previously worked as spot traders with 30 years experience in hedge funds and banks.