This article was originally published on Nadex.com.
The AUDUSD pair has been under significant pressure lately, and we see a bearish case devloping quickly that could thrust the pair into much lower terrain.
Much of the noise this week has centered on trade tensions between the US and China. The potential for increased tarriffs between the worlds two largest economies would have far reaching implications globally. Generally, the tarriffs are seen as bearish particularily for China, given their dependence on selling into the USA.
Tarriffs could also have very specific consequences for countries like Australia. Australia’s economy is heavily dependent on commodities and is a major exporter to China. Currency traders histrically link the AUDUSD’s fortunes to what is happening with China as economic growth there is seen as bullish for Australian commodites.
At the same time as the trade drama is playing out, the dollar has seen an expansion of value across the board against other major currencies. As the data improves, the US has begun a trajectory of rate normalization, and generally speaking, rates are going up faster in the US than elsewhere.
This growing imbalance between rates in the US and other developed nations will have deep impacts on currency markets over time. When we study the shifting terrain in Australia, we see the growing differential in rates as having a particularily stark impact.
Moving forward, we see a bearish case developing quickly for the AUDUSD pair driven by 3 main factors:
- A growing interest rate differential between the Aussie dollar and US dollar, which typicaly impacts this pair greatly
- Challenging technical set ups
- Short term geo political tensions between the US and China regarding trade
Growing Interest Rate Differential
Over the past 5 years, Australia’s 10 year Treasury note has had both much higher and lower rates than that of the US.
The consequences are simple; when Australia has a higher yield on their 10 year note, the currency is strong versus the US. When the US has a higher rate, as is the case now, the Aussie is weaker.
The key today is we are at a meanngful inflection point regarding the rate differential. The spread between US rates and AUS rates are at a 5 year high.
Looking at the chart below of weekly closes over the past 5 years, most of the time Australia has had a higher yield. When the US had had a higher yield, (any number above 0 on the Y axis below), AUDUSD has never been priced above .7900
In looking at the chart below, it is clear that when the difference between the US 10 year minus the Australian 10 year moves positive, meaning the US yield is higher than the Australian yield, the price of this pair moves much lower. These are the weeks in the upper left quadrant on the chart below.
When the Australian yield is higher, price moves higher. The weeks where this has been the scenario is the lower right quadrant.
As yields are higher in the US now, and only seemingly set to move even higher, we believe this could have an impact on the price of AUDUSD and cause it to move lower.
chart built by Jason Pfaff
Looking ahead, we only expect this differential to swell in dramatic fashion in favor of the US dollar. The Royal Bank of Australia has given no indication that a rate move will happen any time soon.
This is in direct contrast to the US, where the Fed could hike two more times in 2018 and two times in 2019. Under that scenario, the dollar could expand recent gains an additional 3-6%, and the 10 year Treasury in the US could move to a yield of 3.30%.
At the close of last week, the US 10 year traded around 2.92% on the yield, with the Australian yield landing around 2.65%, for a differential of .27%.
With the US clearly on a path to continue to hike rates, we see a path developing that would result in this differential doubling to around .55%.
The differential is already the widest it has been in 5 years. Having it grow by that much could result in a steep move for the currency.
The AUDUSD pair has been mired in a downdraft for much of 2018. Looking at a daily chart, it has recently seen a double top, which typically is seen as a bearish devlopment and entrenches a resistance level. We have also had a "death cross" form, which is when a 50 day moving average crosses under a 200 day moving average. Again, a potentially bearish development.
The pair is currently at the trendline forming the bottom of a bear flag shape, and a break of that trendline, which we could be potentially seeing now, could trigger lower values in the near and longer term. The key level is .7350, which we are periously close to. A break of that level could send the pair tumbling to the .7000 level. In our opinion, that would have this pair trading in the .6700 - .6900 range in 2018. We do not see a meaningful level of support until the 2016 swing low of .6814
chart built by Jason Pfaff in TradingView
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