Aussie Set for Increased Summer Volatility

Volatility levels in the Australian Dollar have risen to their highest levels in roughly 18 months, as changes in the policy stance at the US Federal Reserve are coming in conjunction with a major cash squeeze in China.  These events have added a layer of confusion to the market’s underlying sentiment with respect to high-yielding currencies and with the AUD/USD trading at its lowest levels since 2010, there is clear potential for these trending moves to continue. 

Specifically, the growing prospect that the US Federal Reserve will begin trimming back on its historic third round of quantitative easing (QE) stimulus has created a bullish scenario for the US Dollar (pushing the AUD/USD to new long-term lows).   This is because any reductions in monetary injections from the central bank will limit the available supply of the currency.  At the same time, the People’s Bank of China (PBoC) has signaled its intentions to limit credit growth sending the country’s benchmark stock indices into a renewed bear market.

Central Bank Expectations 

So, the main question deciding the fate of the Aussie as we move forward into the summer will be whether or not markets are mis-assessing the true intention of each of these central banks.  But in either case, volatility is currency pairs like the AUD/USD and the AUD/JPY is likely to remain elevated as these reasons for uncertainty are still far from seeing anything resembling a resolution.  China is a Australia’s largest export market (largely based on raw materials exports) so any news of weakness in China will translate to continued downward pressure on the Aussie.

AUD Still Heavy at Long-Term Lows

Given all these factors, there is little on the fundamental side to help the Australian Dollar, despite the fact that the currency is cheap relative to medium term averages.  The one-month implied volatility in the AUD/USD has risen as high as 15.5%, which is the most drastic monthly fluctuation since December 2011.

Stock Market Correlations 

Another factor to consider that the Australian Dollar is highly correlated with stock markets and the wider global sentiment with respect to equity markets.  Because of this, any weakness in benchmark indices like the S&P 500 is likely to be interpreted as a negative for the Aussie as well.  Price action in both the S&P 500 and the CSI 300 Index (which tracks China’s largest companies) have shown significant reversals in recent weeks.  The S&P 500 is now trading back firmly below the 1600 level, and the CSI 300 has seen single-day declines of more than 6% already this month.  From its 2013 high, China’s CSI 300 has already seen declines of more than 20%.

Analyst forecasts for GDP growth in China have been revised lower (below 7.5%, which is the PBoC’s target rate for the year).  US GDP forecasts are likely to start seeing similar revisions if we see additional evidence that the Fed will start making reductions to its $85 billion in monthly assset purchases.  When seen together, all of this paints a cloudy picture for the Australian Dollar and ultimately suggests that, from a fundamental perspective, the currencies renewed downtrend has yet to find a bottom. 

Technical Analysis Perspective

AUD/USD:

Aussie Set for Increased Summer Volatility
Aussie Set for Increased Summer Volatility
 

Chart created by MQL5.com 

The AUD/USD has seen major declines in recent weeks, but looking at the pair from an indicator perspective, there is still room for this bear decline to extend its move.  There is little in the way of historical support at this stage, but we are currently dealing with the 38.2% Fib retracement of the rally from late 2008 (when prices were still trading in the low 0.60s).  Given the structure, any moves below this Fib support at 0.9140 will be a massive negative for the pair, as the next Fib support cannot be seen until 0.80.  This is the 61.8% Fib retracement of the same move and coincices nicely with the lows from May 2010.

AUD/JPY:

Aussie Set for Increased Summer Volatility1

Chart created by MQL5.com 

The AUD/JPY is generally used as a gauge of market risk, and the overall picture in recent weeks has not been positive.  Prices have moved lower to the 50% Fib retracement of the move from 74.40, which is now seen at 89.80.  The AUD/JPY is another pair that is seeing little in the way of historical support levels, so the key way of assessing support levels will be to look at Fib measurements.  Next downside target is seen at 86.20.

S&P 500:

 Aussie Set for Increased Summer Volatility2

Chart created by MQL5.com 

For correlation reasons, it is important to watch the S&P 500 as well, and the next downside target in the index is seen at 1530.  Bias remains lower as long as prices hold below resistance at 1605.  For more forex tips, tools, and trading signals, visit MQL5.com.

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