Tight bond spreads continue to weigh on the Aussie dollar


Almost everywhere you look at the moment when reading research about the Australian dollar the first thing you’ll see is a discussion about the lack of yield pick up between Australian bonds and their US counterparts. ​​

It’s the big story which explains why the Aussie dollar has struggled to break its big downtrend from its last foray above 81 cents. Indeed, while it’s the dominant conversational and research narrative the collapse in the bond spread – from around half a percent positive in the 2-year back in September to just slightly negative this morning – has been responsible for big falls in economist and strategists estimates of AUDUSD “fair value”.

That means that even though iron ore has recovered strongly from recent lows, that copper is still up at levels not seen since 2014, that global growth continues to point solidly toward another good year in 2018, and that stock price rises across the globe are suggestive that investors are in a positive mood, the Aussie dollar is still languishing.

To be fair,the Kiwi and Canadian dollar isn’t exactly shooting the lights out either – even though the US dollar is under a little pressure.

But for the Aussie of compression to and now through US 2-year rates which is the big handbrake on the Aussie dollar is the show stopper. It’s this collapse in the yield spread – and what the gap between it and where the AUDUSD rates is presently – which is dominant narrative,

Indeed, there is much focus on exactly where AUDUSD was last time the 2-year spread was negative – below 55 cents.

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Anyway, we’ll see what time brings with this spread and the AUDUSD.

As I wrote earlier, readers know I’ve been banging on about this for some time, so the fact I’m now reading it everywhere could be a sign that for the moment it is baked into the cake. That suggests while stocks remain strong, while metals and iron ore are doing likewise, then the chance for an AUDUSD break out is growing.

The key level to watch is 0.7635/40 a break could signal a run of a cent or more.

In other forex market developments, the Euro surged on the dovishness of the FOMC minutes, strong EU data, and questions revealed about the outlook for QE in the ECB’s own minutes. As I noted in the wake of the FOMC minutes last week there is a chance that this disquiet over the Fed continues in the weeks leading up to the next meeting in the middle of December. Whether or not that is the case will in no small measure be influenced by the three speeches from Powell, Dudley, and Yellen on Tuesday and Wednesday.

The commodity bloc lagged the rally in the Euro and GBP. That’s most interesting when you consider the Canadian dollar’s performance even as Oil surged once more. Likely after a solid improvement and break of an important trendline, USDCAD traders are just a little more circumspect after last week’s disappointing retail sales data. The bias is lower, however. The Kiwi is grappling with and struggling to sustainably best trendline resistance. But it has managed to stay just above which is positive.

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