Sell Australian Dollar Against US Dollar Suggest Strategists Citing a Chinese Headache
A Trump trade war with China as well as a tightening of Chinese credit could be the twin catalysts for a decline of the Australian Dollar, say forecasters at Morgan Stanley who reckon it could be worthwile betting against the currency as a result.
Meanwhile, analysts at Societe Generale have recommended a similar trade that looks to take advantage of weakness in the Aussie.
The calls come as the AUD to USD exchange rate trends higher from the sub 0.72's witnessed in mid-December to the +0.75s witnessed in early February.
The rally has been unable to break above 0.76 and many will be asking whether AUD/USD's period of appreciation is in fact over.
A Chinese Achilles Heal
Chinas has for so long been a source of Australian Dollar strength, but this support could soon dry up as geopolitics shift under the new Trump administration.
“Asian economies including China are potentially most vulnerable to protectionism in our view. Indeed, there are signs of China slowing down as illustrated by our MSCHEX index. Credit has tightened, Renminbi (RMB) funding costs are on the rise and the RMB-TWI has increased over recent weeks,” says Morgan Stanley’s chief FX strategist Hans Redeker in a note seen by PSL.
During times of abundant credit when Money Supply (M2) is high, the Aussie does well as a result of in increased purchasing of Australian commodities for building materials and industrial production.
Currently, however, credit is tightening and although the Aussie has not fallen to reflect this, it is expected to fall back in sync imminently.
The chart below shows the close relationship between Chinese Money Supply (M2) and the Aussie.
The Peoples Bank of China (PBoC) current policies are orientated towards raising interest rates making borrowing more expensive so credit and money supply are expected to fall further.
This is in response to the large outflows from China because of the devaluation of the Renminbi as well as to cool the over-leveraged property and corporate sector.
“Yesterday news reports suggested that macro-prudential tightening measures were also being used, with regulators asking banks to curb new loan growth in 1Q17; in particular, to reduce mortgage growth in 1Q17. We think risks are skewed for further upside in onshore rates as liquidity will likely be adjusted after the Chinese New Year holidays," says Redeker.
This is not only bearish for Chinese growth, but the rise in funding costs for a leveraged corporate sector also increases the risks of a deleveraging.
The Aussie, which has been supported by the Chinese government’s infrastructure drive during 2016 is now therefore at risk due to the expected slowdown in investment and growth due to tighter lending conditions associated with deleveraging.
Domestic Strains
China isn’t the only reason for Morgan Stanley’s bearish view of the Aussie; domestic pressures, including an against-the-global-trend low inflation in Q4 are also weighing on the outlook for the exchange rate.
“Recent economic data out of Australia have surprised to the downside with GDP growth, employment, retail sales, and most recently, 4Q CPI numbers disappointing market expectations.
“This contrasts with the broader trend of improving data and emerging signs of reflation from other G10 economies,” notes Redeker.
Trump Talk
The Dollar may be at risk from Donald Trump trying to talk it down but this is unlikely to be able to restrain bulls, say Morgan Stanley.
“Recently, AUD has been supported not only by commodities and the hope for higher fiscal spending globally but also from a weaker USD following verbal intervention from President Trump.
“We, however, are of the view that the USD cannot be held lower for long amidst improving data, expectations for fiscal spending and pricing in of Fed rate hikes,” says Redeker.
Forecasts
As a result of their bearish stance Morgan Stanley’s FX team recommend short selling AUD/USD down to a target at 0.69, which is in line with the lows seen in August 2015 after the RMB devaluation as well as in January 2016 when Chinese rates took a step up.
Downside risks to their assessment come from a rise in Chinese and US fiscal spending increasing demand for Aussie commodities.
Societe Generale Recommend Buying AUD/USD Put Butterfly
Analysts at Societe Generale are bearish the Aussie for similar reasons.
"Our statistical model suggests that any fall in Chinese equities or gold prices would weigh on the AUD. Meanwhile, our
economists expect the China growth cycle to turn," said Soc Gen's FX Quantitative Strategist Olivier Korber.
Korber recommends buying a put options on AUD/USD, which would make money in the event the pair fell.
