The Aussie Dollar Found The Air Too Thin Above 75 Cents

Originally published by AxiTrader

The Australian dollar traded to a high of 0.7516 overnight before being chased back to a low of 0.7470 as the US dollar got its mojo back knocking the euro for six and drive solidly through forex markets.

Exactly why the euro pulled back, or the US dollar rallied, when German finance minister Wolfgang Schaeuble joined the chorus saying the euro is too week and on a night when EU data outpointed US outturns is hard to fathom.

Unless of course, you're a chartist. In that case, the euro's move was overcooked and needed a pullback. The result was the US dollar found its feet and whereas its weakness was supporting the Aussie in the past few days its strength was a weight on the rally.

That and the other factor that is an important driver of the Australian dollar and one which I believe is ultimately what will help drive the Aussie much lower if the domestic economic weakness occurs as I fear it will late this year or perhaps in 2018.

Bond spreads.

It's one of the very important drivers for a large subset of Aussie dollar buyers - global international bond managers. These managers, known as foreign currency bond managers, buy Australian bonds as part of their management of global sovereign - and other - bond portfolios.

Often, because Australian yields are usually among the highest in the dollar bloc, Australia ends up with an overweight allocation relative to the investor's benchmark bond index. That purchase is often unhedged because the settings the manager sees as driving the yield pick up are often coincident with a stronger Aussie - or at least a relatively stable one so they can benefit from the yield pickup.

And that means that there is usually a pretty strong directional relationship between the Aussie/US bond spread and the AUD/USD.

This is a long run relationship so I've shown the linkage between the spread, the Aussie, and the US Dollar Index, over 5 years - as well as taking off the commodity drivers - so readers can see the strength of the relationship.

In this context, you can see why the Aussie remains offered every time it rallies recently. This is the major handbrake on the AUD/USD rally and a source of underperformance on the crosses as bonds of other nations rise. Even if that is from ridiculously low levels.

Think of it as the competition for capital getting more intense and Australia losing ground.

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That's something that makes S&P's downgrade of Australian banks, and its threat to downgrade Australia all the more real. Australia is already losing its shine in terms of portfolio investment at present.

Of course, a lower Aussie would be a boon economically. And one the economy might need if consumers focus on debt.

Anyway. Looking at the charts yesterday's the 0.7440/50 remains key short-term support as you can see on the 4-hour chart below.

If that level breaks then a further drop is on the cards.

Yesterday's price action was awful though so AUD/USD would need the US dollar to weaken and price to move above 0.7515/20 for any further topside to open up. While the euro looks like it is retraceing that possibility seems remote.

Have a great day's trading.

Written By: Axi