The AUD Can't Break Higher If Markets Are Worried About Deutsche Bank

Originally published by AxiTrader

Quick Recap

The Australian dollar failed again at 77 cents in trade over the past 24 hours as traders again respected the strength of overhead resistance and the supply.

That the reversal was only mild in nature was no understatement with the AUD/USD sitting around 0.7670/80 before the news hit that some clients had been pulling cash from Deutsche Bank AG (DE:DBKGn) NA O.N. (NYSE:DB) ignited fears, and memories of the dark days of the GFC and the collapse of Lehman Brothers.

Such an environment is never good for risk assets like the Australian dollar.

What You Need To Know

Yesterday I wrote there were no reasons to sell the Australian dollar besides technicals.

That all changed overnight with the release of a Bloomberg article which said "amid mounting concern about Deutsche Bank AG’s ability to withstand pending legal penalties, about 10 hedge funds that do business with the German lender have moved to reduce their financial exposure". Those hedge funds are moving cash from Deutsche to other Prime Brokers the story said.

This is of fundamental importance for markets because Deutsche is at the heart of global finance and designated a G-SIB (globally systemically important bank). Back in June the IMF said " among the G-SIBs, Deutsche Bank appears to be the most important net contributor to systemic risks.”

So when news of clients withdrawing funds from the bank hit, traders and investors naturally recalled the last time they faced such news and pulled out that playbook, which does not include buying Aussie dollars or other risk assets and commodity currencies.

Chart

Why that is so is best explained with reference to the role the Aussie dollar plays in a lot of traders, investors, and hedge fund portfolios.

The AUDUSD is the 4th most traded currency pair on the planet. That size belies the size of the Australian economy or the importance of the Australia on the global scale. But many traders use the Aussie as a pro-cyclical bet on global growth.

That combination means that these traders have Aussie dollar positions which are larger than their investment benchmark/index, would suggest.

In the good times that is great. But when things go awry, when global growth looks like it is slowing, or when markets get into a funk, investors get closer to their index positions. That means they liquidate Aussie dollar positions.

It's one of the reasons the Aussie dollar never usually does well when markets are in a funk.

Even just this year the Aussie dollar has drifted lower whenever markets have gone off and risk appetite has waned. Certainly the Aussie has done much better than could have been expected but it has still been under pressure.

It's just a reflection of trader's reaction function to market turmoil and stress.

All of this means that AUDUSD bulls will be watching how the Deutsche Bank fears play out very closely. A loss of confidence in a financial institution is an existential crisis. So while this story is only about two handfuls of hedge fund clients the seed of doubt will now be planted across investors in all markets. And it won't just be about Germany's biggest bank - investors will wonder about the very linkages the IMF so helpfully highlighted in June.

I certainly hope investor confidence can be restored, and quickly. Because these confidence based liquidity issues can take on a life of their own.

So my bullishness for the Aussie dollar is tempered still by the overhead resistance in the 0.7700/0.7830 zone we've been talking about, but also by potential clouds on the horizon for global finance.

Have a great day's trading