FxWirePro: Aussie on a see-saw on China slowdown and RBA’s repricing – AUD/USD RRs warrants bidding vanilla puts

The underperformance of Aussie dollar, driven by some strident slippage in Chinese bulk futures, persisted, even though AUDUSD (0.7980) did claw back towards 0.8000.

China slowdown to prevail and AUD’s underperformance to persist: The ongoing structural Chinese slowdown is expected to remain orderly, which should provide reasonable support to Australia’s commodity exports. Our commodity strategists see iron ore prices supported above $60/t in 2018, but coking coal prices to decline. There are thus downside risks to the AUD from these factors. 

Aussie strength on RBA repricing: The Aussie dollar is expected to strengthen in 1H’18 as the market raises the likelihood of RBA tightening in 2H’18. Moreover, the resumption of the US dollar downtrend should provide an additional shot in the arm to the AUDUSD exchange rate. The gains, however, are expected to be modest.

Consequently, the uptrend appears less powerful after AUD faltered in front of 0.8040-50 suggesting more retracement towards 0.7925-50 especially if USD holds in Asian trading.

Over the course of Q1’18, we foresee AUDUSD to retest 0.75 area seen in early Dec 2017. This seems most likely when interest rate markets remain no change in the RBA cash rate this year and if the prospect of increased supply chills the recent commodity price rally. But a firmer US dollar is probably necessary to get as far as 0.75.

While AUD has been a strong USD-hedge candidate since one-touch AUD put pricing benefits from wafer thin forward points and risk-reversals that renders negative carry of AUD selling almost negligible, and the underlying itself provides fundamental diversification for the broad reflation theme given Australia’s unique domestic headwinds, as well as useful equity beta should the breakneck rally in stocks hit a roadblock.

That AUD is worth selling via options does not necessarily imply we find AUD risk-reversals “cheap” enough to warrant owning vanilla AUD puts outright, (please be noted that mounting bearish sentiments in AUDUSD 6m-1y tenors, refer above nutshell) – indeed, recent spot-vol correlation in AUDUSD has been sharply positive (spot up, vol up) in defiance of the persistent bid for AUD puts on riskies, indicating much better value in owning AUD calls rather than puts on the surface (refer above chart).

In light of this, the reduced risk-reversal sensitivity of one-touches is preferable to vanillas while still retaining healthy mark-to-market P/L sensitivity to spot moves. Off spot ref. 0.8035, consider 2M 0.77 strike AUD put/USD call one-touches for 20.7% indicatively.

Currency Strength Index: FxWirePro's hourly AUD spot index is inching towards -74 levels (which is bearish), while hourly USD spot index was at a tad below -108 (highly bearish) at the time of articulating (at 12:39 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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