Black Bear, Harmon (photographer), 1942
It’s been a while. Last time I posted was on March 12th. I went bullish then; the market bottomed two days later and it’s been a decent month or so. I’m turning increasingly bearish now. With seasonality turning back in favour of the bears and plenty of indicators showing underlying market weakness, I’ll likely be taking pot shots at the break higher in a week or so.
I’m switching things up as I still haven’t found a satisfying format for this sub. For now, the plan is:
find a market-related question on Reddit that is topical.
post about it.
This week’s question:
“Why is the AUD and NZD depreciating so much more than other currencies?”
Does the question make a correct observation?
Yes, and it’s something I’ve noticed for a while (hence playing the NZDCAD short I mentioned a few months ago).
EURUSD at the top, AUDUSD at the bottom. Relatively correlated until early this year, now increasingly divergent.
Is it the right question to ask?
No, though perhaps it’s in the wording. I would go for:
'what does the depreciation of AUD compared to EUR and USD tell us?'
Also cutting out NZD here as AUD is the dominant currency between the two and AUDNZD have been in a range for around 10 years. So, happy to assume that there are no major drivers that are affecting NZD over AUD and that whatever conclusions we make with regard to AUD, NZD will follow suit.
What’s the answer?
It’s tied up in the weakening commodity market, weakening global economy and slow drift into safer currencies. It’s an early warning that there will be some stormy waters in equities later this year.
Oil gave a great opportunity to fade the gap on that jump higher when the Saudis announced they were trying to tighten the market. When you’re reading ‘this is the last chance to pick up oil at $80’, those who control the oil market are reducing production, and the thing has been going down for over a year, it’s a decent bet to fade the gap. Sentiment is still far too bullish oil while commodities are in a bear market.
This month lumber closed at multi-year lows.
Copper (often tied nicely to AUD) broke down last year and has struggled to retrace.
Copper weekly with the breakdown from range highlighted. Let’s see if it can hold this level. It’s a volatile one - if there’s some optimism over the next few weeks, a break higher will have me fading any large up days into resistance.
So, yes, commodities look to be weakening. AUD likes a strong commodity market. Is this a healthy pullback or a sign of a sick global economy? AUD likes a strong global economy to hoover up its exports. A strong China (which requires strong global trade) is also favoured.
Yield curves are telling us no, no, no. This is not a healthy market. Here’s December of last year and, well, I’ve put 1st May as these will be the figures when the market opens in May:
US Yield Curve. Orange - a few months ago. Red - now.
What’s this telling us? That at present the market is positioning for imminent Fed cutting, likely within the next 6 months. On the eve of another Fed rate rise. This is not a good sign.
A reminder of what the YC looks like at the end of a bull market/ phase (red, 2007) and at the start of a bull run (green, 2009). What does our current YC compare to more?
The real money knows this risk of weakness in the market and is repositioning. Large caps are holding up (therefore giving the illusion that the market is holding up) as money runs to safety. There are plenty money managers out there that are long only and need to be in equities - they will hide in the cash cows of Microsoft, Apple, etc.
In the early stages of these kinds of moves, FX money ditches carry trades and heads by default into the Euro (lower rates so it makes up the other side of those carry trades). When the crap really hits the fan, the Euro will crumble as well.
All this together = weak AUD (& NZD).
What’s the trade?
So, we’ve come to a conclusion as to why AUD is weak. Do we jump right in and short AUD?
Mini-question:
Has the market already priced in my conclusion?
Well, I would say at present the best trades are out of their starting blocks and we’re a bit late to the party. Waiting on a pullback for most.
However, that Yen move last week was interesting, wasn’t it? I think there’s some opportunity in there. Huge reaction to the BoJ doing nothing. Perhaps they are looking at the YCs too and thinking that inflation will come down for them, rather than having to force it.
Here’s a nice mirror image for you:
Japan/US yield spread (top) and USDJPY bottom. Like one of those lake photos when there’s no wind. Until March this year. Both charts having been going in the same direction since then.
March. Anything happen in March? Think there was some kind of issue with banking in the US. That’s an interesting coincidence, isn’t it?
Let’s see how yields react around the Fed this week. I suspect that they have topped and USDJPY is having a blow-off that will soon reverse.
AUDJPY will be pulled up by default because of this Yen weakness, particularly if there is one more ‘risk-on’ move in equities. So, AUDJPY for a short could be a good shout. But…..
For me, AUDJPY hasn’t got any clear resistance areas lining up to short into- could be different for other traders. So, do we ditch the idea?
Hmm, what about bringing that pesky NZD back into the mix. We already figured it was a decent proxy for AUD anyway.
Turns out NZDJPY does have a few areas of interest above, and if it gets there it will be hitting 2022 highs. If we still have the same view when (if) it reaches the top of this recent range, this looks like a promising short. Initial target back down to 81, but if it works out to there, worth holding at least part of the trade to see if 75 is hit.
So, what does AUD weakness tell us?
the market is readying for a risk-off moment
another nail in the commodity bull market narrative
we could use this weakness for a short NZDJPY, if the timing is right and the price action lines up
Have a different opinion? Want to talk through a point some more? Pop in a comment below and let’s chat.
Be patient and trade well.