Originally published by AxiTrader
The Australian dollar is sitting just above 78 cents this morning at 0.7803.
That's just a little under 6 cents higher than where the AUDUSD finished 2016 for a gain of 8.1% over the course of 2017. But while the Aussie traded from around 72 cents up to 81 cents and back before this last month's rally the reality is that at just 9.64 cents 2017's range for the Aussie was well below average.
Since 1971 the average range for AUD/USD has been 13.59 cents, since the float it has been around 14 cents and for the last 20 years, it has traded an average range of 15.32 cents.
But, like many markets in 2017 the Aussie dollar's range spoke of an overall volatility compression - even though it probably didn't feel like that at times.
Given that it would have been a very different year for the AUD/USD in terms of gains had it not been for the rally in the second half of December and given this is Aussie's strongest start to a year since 2015 it's worth wondering if the gains are sustainable - or not as may be the case.
To do that it's worth breaking down the driver for the Aussie dollar's rise, fall, and rise again over recent months.
Key to the rise was US dollar weakness, optimism about the Australian economy and what that might mean for RBA rates, solid commodity prices, and interest rate differentials which offered a small - but material - pickup in this still low rate world. The fall in the Aussie was largely about a change in perceptions about the Australian economy as traders worried about the outlook for consumers and thus a negative impact on RBA intentions and the spread between Australian and US (among others) bond rates.
It was the collapse in that AU-US 2-year spread into negative territory which was coincident with - a big driver of - the Aussie dollars big fall - from just above 81 to 75 cents in December. As I wrote during November, the Aussie would likely remain under pressure until that spread turned.
And that is exactly what happened last month as a convergence of commodity price strength, a weaker US dollar, and a continued flattening of the US yield curve all supported the Aussie while the bond spread was able to rise back into positive territory.
Granted, a 5 or 6 points the AU-US 2 year spread is hardly worth worrying about. But the key here is that we saw the compression trend pause and that - coupled with the surge in commodity prices - took a weight of the Aussie.
So here we are at 78 cents. And my sense is that the key drivers of the Aussies moves recently will remain the dominant factors driving Aussie dollar moves.
Looking ahead the US dollar is key. It's key because as the other side of the cross it's move impact AUD/USD. It's key because a weaker, or stronger, US dollar feeds into commodity prices which in turn feed into the Aussie side of the AUD/USD exchange rate. And the US dollar is key because it is likely to be a derivative and beneficiary of perceptions about the outlook for the US economy and US rates vis a vis Europe and the rest of the world. That filters into AUD/USD via both the US dollar side of the cross and the bond spread.
In a year of continued, perhaps improving, synchronised global growth the Aussie should benefit. But if the tax cuts in the US add to already robust economic momentum and shift the narrative around the fed and thus bonds policy divergence and interest rates could weigh.
So when I look ahead a see another year of range trading.
I'm not in the camp which says the Aussie should collapse under the weight of the US dollar. But that is clearly a risk. So too is my expectations that bonds will rise and stock market volatility will increase. But a solid global backdrop of growth should temper some of these negatives.
So another 9 or 10 cent range seems likely for the Aussie with the chance of an extension toward the long run average. The slant I'd be looking at is 0.72-0.82 as an inside range. The chance of an upside extension is there is the US dollar remains weak and global and domestic growth strong
Looking at the charts here's the 2-year uptrend which I'm pretty sure we'll spend some time talking about over the months ahead.
Have a great day's trading.