The US dollar, as measured by the USD Index, reached a 15-month high of 96.85 on August 15th. Three weeks later the AUD/USD posted an 18-month low of .7085 and looked to be heading much lower.
This disparity is due to the simple fact that the Aussie dollar is not a component of the USD Index.
As the USD Index has drifted lower over the last few weeks, the AUD/USD has rallied close to 3% higher and pushed against the .7305 level during the Asian session today. Much of the recent rally has been a result of the perceived de-escalation of the tariff tensions between the US and China (and the PBoC’s comments that it will not weaponise the Yuan as a retaliatory strategy).
Since China is the destination of most of Australia's mineral and raw material exports, and the Yuan is traded as a non-deliverable forward, the AUD/USD has become the trade-tension risk proxy for Forex traders. In short, as the tariff talks become more combative the AUD falls, and vice versa.
As the AUD has recovered this week, there has been market commentary that suggests the AUD could extend higher and beyond the scope of a corrective move. We don't agree with this outlook for both technical and fundamental reasons.
Technically, the pair is still trading below a declining tops line which dates back to the .8135 level last traded in mid-January. This downtrend line comes in around .7425 and only a trade above that level would negate the established downtrend.
From a fundamental perspective, the interest rate advantage between the USD and AUD is currently at 50 basis points in favour of the USD, which is a 20-year high. After the FOMC lifts the US Fed Funds target by 25 basis points next week, this spread will widen to 75 basis points.
Furthermore, based on the forward projections of the FOMC's rate forecasts, there's an 80% chance for another rate hike in December and a 55% chance for another in March 2019. If these projections come to fruition, within six months, the rate advantage between the two currencies will be 125 basis points.
On the other side of the coin, the RBA has been clear that there's only a small likelihood that they will move the current overnight rate off the historic low of 1.5% over the next 12 months.
With these facts in mind, we suggest medium-term traders to remain vigilant to the AUD/USD downtrend.
The EUR/USD traded to a 2-month high of 1.1785 during yesterday's NY session. We expect the corrective move in the pair to run out of upside momentum before next week's FOMC meeting.
GBP/USD
Our short position in the GBP/USD from 1.3145 is about 100 points offside as UK economic data has printed firmer this week. We still see the headline risk for the Sterling skewed to the downside as Brexit negotiations continue today.
The extension above 112.00 in USD/JPY this week continues to hurt our USD/JPY position. As before, the 112.45 level drew selling from exporters and our suggestion to sell at 112.65 was not filled. With the quadruple-witching expiration in the US today, we could see some "risk off" trade.
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