Soc Gen Betting on an Australian Dollar Decline
The Australian dollar’s advance against the US dollar is tipped to see its multi-month advance against the US dollar fail by strategists at Societe Generale.
The AUD to USD conversion has been moving higher since the start of 2016 and closed the first day of the new month at 0.7678.
The currency was the third best performer against the under-fires US dollar in the week past, following closely behind the Swedish Krona and the best performer, the New Zealand dollar.
As the currency rises questions are now being asked as to whether the Aussie dollar has advanced to unsustainably high levels that could potentially derail the economy's growth trajectory.
Analyst Richard Rennie at Westpac recently chatted to the RBA Governor Glenn Stevens and based on what Stevens revealed on the AUD’s valuation he offers his views on the currency’s outlook here.
The latest institutional analyst to offer a view on the Australian dollar is Olivier Korber at Societe Generale who believes the AUD to USD exchange rate is getting ‘toppy.’
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As a result of the view that the Aussie is potentially due a turnaround Korber has initiated a strategy to take advantage of a pullback in strength.
“AUD/USD risk reversals (RR) fell massively along with AUD appreciation, to such an extent that they are now very low on a historical basis. The odds are clearly oriented towards an increase in the implied volatility of low strikes,” says Korber.
Korber notes that 1m puts on AUD/USD are now “really cheap.” A put option allows speculators to take advantage of a financial products decline.
“Buying a put with a topside knock-in (KI) barrier requires the spot to move in the ‘wrong' direction to activate the option and subsequently fall to benefit from its downside convexity. The negative AUD/USD skew lowers the implied probability of activating the option on the topside and therefore significantly cheapens the exotic option compared to a vanilla,” says Korber.
Now the mechanics of the trade are complicated, but it is the underlying message we are interested in here.
The Australian Dollar May be Overshooting
The crux of Soc Gen's trade recommendation is the Australian dollar is too expensive.
Commodity-linked currencies have substantially appreciated with the recovery of oil and metal
prices during Q1.
As the oil/dollar negative correlation is apparently weakening (both oil prices and the dollar are down this week), it may be the time for a consolidation in currencies such as the Australian and Canadian dollar argue analysts
Furthermore, "with copper prices and the USD 2y swap rate (Graph 2). Mean-reversion assumes a weaker
AUD and/or a rise in the explanatory variables. Fed dovishness excludes the possibility of upside in short rates for the time being, while the rally in commodity prices might run out of steam in the next weeks," says Korber.
Societe Generale also note that while the RBA is unlikely to cut rates on 5 April but should not welcome the recent appreciation of the currency.
Manufacturing activity in Australia grew by its strongest pace since 2004, confirming how well the country is weathering the stronger currency and the slowdown in China.
Chinese data also surprised to the upside with manufacturing activity expanding for the first time in 8 months according to the government's official release.
Increases were also reported in the non-manufacturing sector. Although the Caixin index still sees a contraction, a sharp improvement was also reported.
The Reserve Bank of Australia is scheduled to meet next week and these reports will help to ease any concerns they may have about AUD/USD reaching 9 month highs.
From a technical perspective, AUD/USD is approaching a long-term horizontal resistance at 0.77.
The 0.76-0.80 level acted as a consolidation region in H1 15, and all in all, the upside seems capped below 0.80 by the bearish trend line initiated in 2013.
In the views of Soc Gen, now is the time to bet on a turn in direction.
