As “Risk On” sentiment consumes the markets, the Australian (“Aussie”) Dollar is currently in rally mode. Since bottoming in March, the Australian dollar has rallied to climbed to a 15-month high of AUD/USD $0.7164, a level not seen since April 2019.
“Risk On” sentiment in the global currency markets has prompted traders to pile back into the once shunned Australian Dollar. We take a look at how traders can take advantage of this macro trend.
Fundamentals
On a global basis, the Aussie’s rally can be attributed to the flood of market liquidity within the global financial markets, investors’ increased optimism over recent developments on a COVID-19 vaccine, and an economic rebound in China, Australia’s largest export market. There is no doubt, that these positive developments in recent weeks has prompted global FX traders to take on additional risk across the FX markets.
On a country-specific basis, the Aussie has taken back ground against the US dollar and Japanese Yen, as widening yield differentials between Australian Government Bonds, and their US and Japanese peers, as well as the Reserve Bank of Australia’s dismissal of negative interest rates, has caused the Aussie to rally against safe haven currencies.
Market Sentiment
As a result of improving market sentiment, the Australian Dollar has surged since March against its FX peers. Since then, the Australian Dollar rose over 26% against the US dollar, and over 25% against the Japanese Yen, to become one of the top-performing Developed Market, and regional Asia, currencies this year.
Technical Analysis
AUD/USD – Bullish
The AUD/USD took a beating in the first quarter of the year, as the COVID-19 pandemic spread throughout the world, and traders dumped risky currencies for safe haven assets. The AUD/USD plunged to a low of US$0.5497 in March, a level not seen since the 2008 Global Financial Crisis (“GFC”). However, since the March lows, the AUD/USD pair has surged off the back of improving economic data from China, as well as increased global optimism over a COVID-19 vaccine, prompting global traders to rush back into the currency pair.
Since then, AUD/USD prices have broken out of a consolidation pattern in May, and haven’t looked back since, reaching US$0.7139 – a level not seen since December 2019. The AUD/USD is also showing strong bullish momentum, as the RSI has been rising steadily in recent weeks. To us, this is a clear indicator that the recent increase in price is backed by solid upward momentum. Lastly, the ATR has been trending lower since peaking at 0.0227 in April, finally breaking below its 20-day EMA. To us, this signals that market volatility in the currency pair has been decreasing in recent weeks, which is a good sign for the bulls.
In terms of market sentiment, it has been in favor of the Aussie since March. The Bull Power Bear Power Histogram rose to 0.00084 from its March lows, its highest since January 2018, as investors have become increasingly comfortable with taking on more risk in the Australian currency. Lastly, since May, the Schaff Trend Cycle has been solidly in green bullish territory, indicating to us that the Aussie is firmly in a bullish cycle against the US Dollar.
AUD/JPY– Bullish
Similarly to its AUD/USD brethren, the AUD/JPY was also hammered in the first quarter of 2020, as the COVID-19 crisis spread throughout Asia, forcing traders to flee the Aussie and take shelter in the Japanese Yen. The AUD/USD fell as low as ¥59.86 in mid-March, a level also not seen since the depths of the 2008 GFC. However, in a similar fashion to the AUD/USD, and for the same reason(s) as well, the AUD/JPY surged off its March lows as increased market optimism encouraged traders to take on more risk in the FX space.
In terms of price action, the bulls have been in the driver’s seat for the AUD/JPY in recent weeks, as the pair rose to ¥75.55 in late July. We must note though, that the pair has faced strong resistance at the ¥76.34 level, with the price pulling back every time it tried to break through. Nonetheless, we think despite this interim obstacle, the price action is still in the bulls’ favor. Further, as indicated by the pair’s RSI, momentum appears to be on the bulls’ side as well. After taking a breather in June, the RSI for the AUD/JPY has been inching higher, as traders try to gather enough steam to make an attempt to breach the ¥76.34 level once again. Lastly volatility in the AUD/JPY, as indicated by the ATR, has been on a steady decline since June, crossing below its 20-day EMA for the first time since mid-February. This is bullish in our view, because it indicates that traders are feeling much better about the prospects for the Australian Dollar relative to the Japanese Yen.
If there were any doubts over the pair’s bullish trend, when one takes a look at market sentiment, we believe these doubts are quickly dismissed. Since March, the Bull Power Bear Power Histogram has strongly been in bull territory, as bullish traders continue to flock into the currency in hopes of a recovery trade. Further, the Schaff Trend Cycle has been solidly in green bullish territory since mid-May, signalling that the Australian Dollar is in solid demand by global traders, relative to its Japanese peer.
Risks
In spite of our optimistic tone on the Australian Dollar, one can’t ignore the ongoing headwinds that the currency faces.
The Australian Dollar may face renewed bearish pressure if concerns over a second wave of COVID-19 cases compels government officials around the world to reinstate their lockdown measures. As a result, this could dampen market sentiment for the economically-sensitive currency. Its commodity-linked nature makes it vulnerable to shifts in economic sentiment, especially during times global uncertainty. To make matters worse, another worrisome issue for the currency are the trade tensions brewing between Australia and China.
Relations between Australia and China have been on the backfoot, as Beijing officials were angered after Australian officials pushed for a global investigation into the origins of the COVID-19 outbreak. A specific point of contention were calls for greater transparency in how China handled the initial outbreak. In a swift response to this, China announced a ban on Australian meat imports, and went on to impose tariffs on other Australian goods. Developments such as this are problematic in our view, as tensions between the two trading partners could hurt the prospects for the Australian Dollar.
Overview
Overall, we are still quite bullish on the AUD/USD and AUD/JPY currency pairs. We believe the improving market sentiment, as well as the accommodating environment will provide strong support for both the AUD/USD and AUD/JPY. Going forward, if this environment persists over the coming weeks, we can see the AUD/USD hit USD$0.7500, while if the USD/JPY can muster enough strength to break through the ¥76.34 resistance level, we think the next stop is ¥80.00.
In the event of a “Risk Off” scenario however, we see the AUD/USD back testing its USD$0.7000 support, with the AUD/JPY pulling back to ¥73.64. Though this is not our base case, we must stress for traders to keep this scenario in mind in case things go south.
Nonetheless, we are currently bullish on the AUD/USD and AUD/JPY pairs.
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