Why Australia’s Fortunes Still Depend on China, U.S.

 

As world markets adjusted to last week’s surprise decision by the FOMC to delay the tapering of its bond buying program, Australian Dollar futures rallied in a broader sell off of the U.S. Dollar, and we could see continuation of the rally on the better than expected Chinese manufacturing data released early this week.

China is Australia’s largest trading partner and Chinese demand for commodities is vital to the Australian economy. The flash HSBC PMI beat analyst expectations and came in at the highest level since March of this year showing that September saw the most growth in China’s factory sector in six months.  This upbeat data could be viewed as a leading indicator for more signs of recovery in China. The number comes on the back of other upbeat data to come out of China in recent months. After spending much of the year struggling, many analysts now believe data suggesting that China could reach its target growth levels this year after all.

The possibility of a turnaround in China should also increase optimism in Australia. Growth in trade between China and Australia has accelerated over the past five years as increasing Chinese demand for ore, coal, precious metals, and natural gas fueled trade between the two nations. Since 2008 trade between the two countries has risen over 60 percent. Accelerating growth in China’s factory sector would increase this demand and is key to strength in the Australian economy.

While last week’s Fed announcement led to massive short covering as traders scrambled to cover their positions. Net speculative shorts were cut in half after the Fed announcement and strong Chinese data will likely continue the squeeze higher. While the move on Fed news may have been driven mostly by aggressive short covering, the boost from China may give the recovery in AUD futures some real momentum as they test levels not seen since min-June.

Unfortunately, signs of strength in China may not be enough to fuel recovery in the AUD. A busy speaking schedule for Federal Reserve governors could threaten to derail the recent rally in AUD futures. The Fed surprised markets by electing to delay the taper of its bond buying program. This was completely unexpected and markets were positioned with the full expectation of a September taper. Leading into the release of the statement net speculative positions in U.S. treasury futures were the most short they have been in over three years.

The shock sent the USD sharply lower against major currencies including the AUD. Looking at the way markets reacted to the Fed and how they were positioned beforehand it is obvious that the market was not expecting a delay in tapering. While this surprise coupled with data from China should help follow through in an AUD rally the speculation over the future of QE could end hopes for a second half rally in the currency.

Although net short positions in Australian Dollar futures are continuing to fall there are concerns that the speculation surrounding the future of QE could send the AUD lower. With 11 scheduled speeches from Fed governors this week uncertainty is likely to increase as traders look for more clues about when the taper may happen.

Net speculative positions show that as the market is beginning to position for further upside in AUD futures another shock could easily increase volatility. No market in the world is immune to surprises from the Fed, but AUD futures and the continued strength of Australia’s commodities should hold up relatively well regardless of U.S. monetary policy if China continues its recent streak of positive data.

James Ramelli is the Moderator of the Live Futures Options Trading Room at KeeneOnTheMarket.com where he actively trades futures and options on futures while educating members on strategies, setups and risk management. He has a degree in Finance with a focus in Derivatives Trading and Financial Engineering from The University of Illinois and has been trading for five years. James appears regularly on Bloomberg T.V. and BNN and writes a weekly column for Futures Magazine.

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