Our catalyst for buying now is today’s release of the Aug. 2 Reserve Bank of Australia meeting minutes at 0130 GMT . If we remember back to the previous meeting minutes, the RBA came out more hawkish than expected and it led to a 500 pip boost in AUD/USD and 400 pip boost in AUD/CAD in the next two weeks. We expect to see something similar, albeit not as dramatic.
We like the trade because we believe there was a lively debate about hiking rates at the meeting. The discussion took place one week after Q2 CPI hit 3.6% y/y (compared to 3.3% in Q1). Officials in the statement emphasized that inflation had peaked but we don’t believe this was a universal sentiment. We also believe upbeat talk about the domestic economy could give AUD a boost.
The downside risks relate to offshore activity. The RBA was incredibly smart/lucky not to hike rates ahead of the wave of risk aversion that hit markets just hours after the decision. They noted external risks and, of course, some of those have come to pass. The risk to our trade is that the market will ignore upbeat comments on inflation and growth and recognize that some of the downside scenarios related to offshore developments have come to pass. Any discussion about cutting rates would cripple our trade but we see it as a less than 1% chance.
On balance, even if the main downside scenario comes to pass, we don’t see a large scope for AUD to fall.
Technicals were the primary driver for a long AUD/CAD trade I entered Friday. I announced the trade on twitter via FX_Button.
Every Friday, shortly before the market close, I take a look at the weekly charts and see if anything jumps out. This turnaround, along with probably reversals in CHF crosses caught my attention. The reversals in CHF look convincing but I’m reluctant to fight the huge upward trend in CHF.
Let’s have a look at AUD/CAD weekly chart.
The dragonfly doji reversal pattern is what jumped out. AUD also looks strong against USD but with this trade I minimize the difficult risk on/risk off trade.
Breaking down the fundamentals also creates a convincing trade. Despite the furor about the soft AUD jobs data and potential rates cuts this year, we are not yet convinced. The RBA took a small step toward HIKING rates at the last meeting, while warning about potential downside risks off shore. It appears as though some of those risks are coming to pass (esp. in US and Europe) but that, alone, will not be enough for the RBA to cut rates. At the same time, Chinese and Japanese data has been stronger than expected.
The same risks apply to Canada. What leaves CAD more vulnerable is that the market is pricing in rate hikes in Canada in the coming six months. With US growth faltering, we highly doubt those hikes are still on the table. If fact, we see the BOC as more likely to cut rates that the RBA.
With this trade, we will look to add around 1.03 for an initial target of 1.05. So far the early Asia-Pac trade has been good to us after a curious rally in CAD in the final 30 minutes of trading on Friday but us behind 35 pips almost immediately. Those losses have been recovered with the pair gaining 80 pips so far this week.
Rumours like the ones we saw today about trouble at SocGen are just the beginning. The three L’s of the rumour-monger are about to take front stage: liquidation, losses, litigation.
The 17% drop in the S&P 500 since the beginning of July is going to generate fund liquidations. Every holding in a funds will get rag-dolled when overall losses in the fund are in excess of 20%. The rumours of withdrawals and liquidations will cause many magnitudes more damage than the withdrawals themselves.
Losses are coming in an economy that is underperforming expectations. As Warren Buffett said: “It’s only when the tide goes out that you learn who is swimming naked.” Financials are especially vulnerable because talk and rumours of losses ALWAYS precede the real thing and cause far more damage.
Litigation is a special ‘L’ in the list because the declines now are coming on the heels of the financial crisis. We are now precisely in the window of time (3-4 years after the event) when lawsuits will peak. Talk of $40-50 billion in lawsuits hitting Bank of America related to mortgage fraud have hit. The desperation in the economy and markets is going to spark others.
We are major believers in following central banks for guidance and with what we heard from the Fed and the RBA in the past 10 days, we think the message is clear. The US is on the precipice of another recession. Now it’s time to sort out who will survive.
Entered AUD/USD at 1.0950 on 26 July. Exited July 26 at 1.1042. Result: +92 pips
Entered with no stop. Greatest open loss: 15 pips Greatest open gain: 110 pips
Sometimes a trade that is bought minutes or hours ahead of data looks whimsical but when it’s good, it’s often because it was set-up long beforehand.
I entered this trade because I became bullish Australian dollar after the RBA minutes on July 18 (my analysis here).
I became further convinced AUD/USD was going higher due to the breakout of the triple-top at 1.0789 on July 21.
I was waiting for a pullback but I knew that I wanted to be long into the decision. At the same time, it was risky to be holding USD positions because of debt ceiling talks and volatility in markets so I minimized those risks by buying hours before the decision on the bottom end of the recent range.
“We’re sure that the record of 1.1012 will fall,” we wrote.
What I should have known better: If I would have thought harder and prepared better, I would have realized what the break above resistance at 1.0789 was forecasting and been ready to buy on the pullback to 1.0800. I also left some pips on the table by covering perhaps too quickly. Eco data is always somewhat unpredictable, so I should have used a stop, even though I was watching the decision.
What I’m happy about: The fundamentals and technicals aligned and I jumped at the opportunity. What’s better than that?
Our best trades over the past month have been on Australian fundamental data so we’re going to continue to stick with what works by buying AUD/USD ahead of the RBA decision at 1.0970. That’s 110 pips below the record high and we’re expecting AUD to blow through that level by the end of the week.
Entered AUD/USA short at 1.0735 on July 4. Exited July 18 at 1.0627. Result: +108 pips
Entered with stop at 1.0800 (65 pips). Greatest open loss: 54 pips Greatest open gain: 210 pips
I entered this trade ahead of the RBA decision on July 4. I expected a dovish statement and explained why in a post RBA Will Remain on the Sidelines, AUD Vulnerable “The Australian dollar is likely to fall if policymakers do not take strong incremental steps toward future rate hikes,” I wrote. “The market is still hanging on to the idea that the RBA could hike in August but we see it as a long shot.”
I wanted to be short USD on July 18 so I exited the trade. Then the RBA minutes were more hawkish than I expected. I wrote this before exiting the trade RBA Minutes Disappoint Doves “What sounded like worries about employment and growth in the statement, read more like a simple adjusting of time frames in the minutes,” I wrote, noting that a high CPI reading late in July could put rate hikes back on the table.” Later in the month I used this perspective and I made money on AUD/USD longs.
What I should have known better: Not much. I could have booked a nicer profit on July 11 but I wasn’t prepared (see my trades in NZD/JPY and NZD/CHF for more).
What I’m happy about: This is what I do best – trades based mostly on fundamentals with some technical underpinnings. I entered the trade ahead of a fundamental event and left the trade as soon as the fundamentals changed. I also didn’t get shaken out by the nearly 300 pip rally on July 11-12.
It’s getting more difficult to avoid insults and hyperbole when describing the debt ceiling imbroglio. Surely you haven’t stumbled here looking for a recap of the day’s news so I’ll spare you the exercise save for a few thoughts. 1) On Tuesday it actually appeared that debt ceiling talks were moving backwards. 2) the real deadline is around Aug. 15. 3) We estimate the likelihood of a downgrade from S&P, Moody’s or Fitch at 70%. 4) the US looks increasingly to be on the precipice of another recession.
We remain short USD/JPY. We booked a 120 pip profit on the first leg of the trade and we’re up 51 pips on the second leg (entered at 78.46). We’re moving our stop down to our entry on the second leg, ensuring that we’re now trading with house money. We really like this position right now and if we were a tad more greedy we would be adding to it. It looks to us like there might be a sharp breakdown below 77.75.
Our latest trade is in AUD/USD which is hovering around 1.0950. It’s going higher. Four days ago on Twitter (July 21) with AUD/USD at 1.0830, we wrote “Beautiful breakout in AUD/USD. That will be testing 1.10.” We’ve climbed 120 pips since then and we’re sure that the record of 1.1012 will fall. The catalyst is going to be a high Q2 CPI reading (above 0.8% q/q on the trimmed mean) today. We are buying AUD/USD asap with the announcement coming on Twitter via @FX_Button. We will hold it until the news turns better on debt ceiling talks.
Dovish commentary from the Reserve Bank of Australia would have crushed any lingering hopes of upcoming rate hikes but that wasn’t the case at all as the minutes indicated rate hikes could come if the CPI reading next week is high.
What sounded like worries about employment and growth in the statement, read more like a simple adjusting of time frames in the minutes. Officials say some weakness is due to production delays and indicate that growth that was expected to be harvested in Q3 and Q4 is still coming, but not until early 2012.
“The delays in the recovery of coal production and supply-chain disruptions resulting from the Japanese earthquake and tsunami also meant that GDP growth through 2011 was unlikely to be as strong as earlier forecast, with some of the recovery being pushed into the early part of 2012.”
Does this change any underlying theme? We don’t think so. The parts of the minutes that deal with domestic growth are as rosy as ever, certainly more upbeat than expected. In particular, the strength of foreign investment, which officials characterized as “very strong” and of growth tied to Asia.
Virtually nothing in the minutes suggests the next move from the RBA will be anything but a hike. The lone exception would be from some type of external shock. “The downside risks associated with a possible adverse European financial shock looked more significant than had been the case a few months ago,” they said.
THE BOTTOM LINE: the minutes should eliminate any further talk about rate cuts this year, baring an external crisis. Instead, the focus will shift to the July 27 reading on Q2 inflation with the possibility of a hike later in the year on a high reading.
Signs of a slowdown in the Australian economy will force the Reserve Bank to hold rates unchanged on Tuesday and are making expectations of an August hike vulnerable. The Australian dollar is likely to fall if policymakers do not take strong incremental steps toward future rate hikes.
At 0430 GMT, all 28 economists surveyed by Bloomberg expect the RBA to leave interest rates at 4.75%. Yesterday’s unexpected drops in retail sales and inflation cemented those expectations and are cutting into the chance of an August hike.
May retail sales fell 0.6% compared to the 0.3% rise expected. At the same time, the Melborne Institute/TD Securities monthly inflation gauge was flat in June after a 0.2% rise in May; the annual rate fell to 2.9% from 3.3%. Building approvals also slumped 7.9%.
At the previous meeting, on June 6, the market had priced in a 16% chance of a hike. When it didn’t come, AUD/USD fell 60 pips to 1.6080. The pair eventually bottomed at 1.0390 on June 26 but popped back to 1.0775 during last week’s risk rally. What’s critical from a fundamental and technical perspective is that the pair has failed to close above 1.0774 — the high before June’s unexpectedly dovish RBA statement. This will be a key closing level in the day ahead.
The market is still hanging on to the idea that the RBA could hike in August but we see it as a long shot. We also expect the chance of a hike in August to fall to virtually nil if the RBA continues to say: “The Board judged that the current mildly restrictive stance of monetary policy remained appropriate.” The OIS market is pricing in just 15 bps of tightening in the next 12 months.
Given that, AUD/USD is looking rich at the moment (1.0732). Even if the RBA introduces slightly more constructive rhetoric, we think the rally will be short-lived (48 hours max). It will take a significant hawkish shift to propel AUD back toward a re-test of the all-time highs at 1.10. This would manifest itself in something like the Feb. 2010 statement which said: “The Board considers it likely that monetary policy will, over time, need to be adjusted further in order to ensure that inflation remains consistent with the target over the medium term.”