AUD/USD looks increasingly stretched – RBC CM

Elsa Lignos, Research Analyst at RBC Capital Markets, notes that AUD/USD ran into resistance in late February just above 0.7740 and has come off 2% in early March, but it remains the top-performing G10 currency YTD, vying for global first place with ZAR.

Key Quotes

“For those tracking rate dynamics, AUD/USD looks increasingly stretched. AUD/USD against 2 year AU-US rate differentials; while spreads have moved 30bps in the US’s favour since Jan 1, AUD/USD is still up nearly 5%. But as we have been arguing for a while, rate spreads are not the story. (1) Part of the explanation is outright yield (the return of the G10 carry trade means AUD benefits from its status as a relative high yielder in G10). But AUD is also up ~4% YTD against its higher-yielding cousin NZD, so that is clearly not the only driver. (2) AUD benefits from deeper asset markets relative to NZ and unhedged inflows. Capital from Japanese investors has continued flowing into AU bonds. December inflows (the last month for which we have data) were AUD1.6bn, more modest than the November inflow of AUD3.4bn but still showing remarkable resilience in the face of rallying AUD/JPY. Japanese buying only makes sense on an unhedged basis (AU is the highest-yielding liquid G10 market), which means AUD buying. (3) AUD is benefiting from the huge rally in iron ore (prices up 80% in six months, +22% YTD, though down 7% off the late Feb high). That has also supported other hard commodity exporters like ZAR and BRL.” 

“For the rest of Q1, AUD may face some downside risk from the January reversal effect. In a nutshell, we have found that January moves tend to reverse in AUD, CAD and NZD through Feb/March. But beyond that we remain constructive on AUD, at least on key crosses. We have revised our end-Q2 forecast marginally higher to reflect (0.75 from 0.74).”