Australian Dollar Strategy: Time to Sell say Soc Gen

Australian Dollar Strategy: Time to Sell say Soc Gen

1 April 2016, 13:25
Vasilii Apostolidi

0.77 is the next big test in the Australian dollar’s advance against the US dollar, and it is here where the multi-month advance could fail.

The exchange rate has been moving higher in a determined fashion since the start of 2016 and is seen at 0.7673.

Questions are now being asked as to whether the Aussie dollar has advanced to unsustainably high levels.

Analyst Richard Rennie at Westpac recently chatted to the RBA Governor Glenn Stevens and based on what Stevens revealed on the AUD’s valuation he offers his views on the currency’s outlook here.

The latest institutional analyst to offer a view on the Australian dollar is Olivier Korber at Societe Generale who believes the AUD to USD exchange rate is getting ‘toppy.’

As a result of the view that the Aussie is potentially due a turnaround Korber has initiated a strategy to take advantage of a pullback in strength.

“AUD/USD risk reversals (RR) fell massively along with AUD appreciation, to such an extent that they are now very low on a historical basis. The odds are clearly oriented towards an increase in the implied volatility of low strikes,” says Korber.

Korber notes that 1m puts on AUD/USD are now “really cheap.” A put option allows speculators to take advantage of a financial products decline.

“Buying a put with a topside knock-in (KI) barrier requires the spot to move in the ‘wrong' direction to activate the option and subsequently fall to benefit from its downside convexity. The negative AUD/USD skew lowers the implied probability of activating the option on the topside and therefore significantly cheapens the exotic option compared to a vanilla,” says Korber.

Now the mechanics of the trade are complicated, but it is the underlying message we are interested in here.

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The Australian Dollar May be Overshooting

This is the crux of the trade recommendation - the Australian dollar is too expensive.

Commodity-linked currencies have substantially appreciated with the recovery of oil and metal
prices during Q1.

As the oil/dollar negative correlation is apparently weakening (both oil prices and the dollar are down this week), it may be the time for a consolidation in currencies such as the Australian and Canadian dollar.

Societe Generale also note that while the RBA is unlikely to cut rates on 5 April but should not welcome the recent appreciation of the currency.

From a technical perspective, AUD/USD is approaching a long-term horizontal resistance at 0.77.

The 0.76-0.80 level acted as a consolidation region in H1 15, and all in all, the upside seems capped below 0.80 by the bearish trend line initiated in 2013.

In the views of Soc Gen, now is the time to bet on a turn in direction.

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