Australian Dollar: Valuation gap and downside risks – Societe Generale

Societe Generale analysts note AUD/USD remains under pressure, converging on the 0.69 area and the March–April trough near 0.6833, despite a sharp tightening in the 2‑year spread to 39bp. The pair lags bond spreads, while softer Australian inflation and structural selling from lower FX hedge ratios by superannuation funds keep the Australian Dollar vulnerable near term.

Spot lags spreads as risks build

"One footnote to the bullish dollar playbook is that tactical valuations are getting stretched. This usually occurs when currencies are not keeping up with bonds spread."

"It is less so for AUD/USD where the 2y spread tightened to 39bp, completing a whopping retracement of more than 80bp since March. Spot lags the 2y bond spread by a significant margin."

"The pullback in industrial metals (iron ore) doesn’t help and puts the AUD in jeopardy of testing the March–April trough at 0.6833. Inflation Down-under surprisingly slowed to 4.0% yoy in May from 4.2% according to data published overnight. Core however accelerated more than expected to 3.6% from 3.4%. "

"On more inflation print for June is due before the next RBA meeting in August but the hot core almost certainly guarantees another hawkish pause. The reaction in money markets was muted. The implied odds of another 25bp hike by year-end hangs in balance at around 55%. Employment data will be published tomorrow."

"One cannot overlook the structural headwinds from declining FX hedge ratios among Australian superannuation funds. APRA data show offshore equity hedging decreased by 0.4pp to 23.2% in Q1. A reduction in hedging reflects the view that investors are happy to stay unhedged to capture FX gains if the AUD weakens. Until Fed pricing turns less hawkish, flow dynamics could continue to weigh on the currency near term."

"AUD/USD has extended its phase of pullback after slipping below its 50-DMA (now at 0.7130) earlier this month. The pair is gradually drifting toward the March low around 0.6850/0.6830. While the decline appears somewhat stretched, it will be important to observe whether the pair finds support in this zone. Should a rebound materialize, the high achieved earlier this week near 0.7020 could act as a short-term resistance."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)