Forex News and Events:
The US will publish jobs data at 13:30 GMT today. The general consensus is the continuation of weakness in US labor market due to difficult weather conditions US went through over the past months. For a soft reading above 110K, the market reaction should remain limited, only a sizeable disappointment should revive speculations that Fed may step back from its tapering program. On the other hand, a better than expected reading should confirm Fed’s faith in US recovery and push the US 10-year yields back above the Fibonacci 61.8% of 2.75% on January-February pullback. In Australia, AUD extends gains as RBA keeps the policy unchanged in March. In today’s newsletter, we question if the AUD is overvalued.
Is the AUD overvalued?
The Reserve Bank of Australia kept its cash rate target unchanged at the historical low of 2.50% in March policy meeting. The RBA restated that the prudent course is stable rates and reiterated that the AUD remains high by historical standards. We decided to examine Aussie’s value from a different angle to answer the following question: is the AUD over-valued?
On Trade Weighted Basis…
While assessing value to a currency, here AUD, the most relevant action is undoubtedly to filter out the trading partners, then to examine the relative valuation between the inspected country and its trading counterparts. In this respect, we have built the Trade Weighted AUD Index, referred as TW-AUD Index, to realize how strong the Australian dollar has become over the past years. TW AUD Index is constructed to methodically take into account the extent of Australia’s two-way merchandise and services trade with its respective partners, the variation of trade relations through years and obviously, AUD’s value in terms of trading partners’ home currencies. The base period for TW-AUD Index is January 2000=100; the trade weights are updated on yearly basis.
The conclusion of our exercise confirmed RBA’s concerns regarding a “still strong AUD”. The TW-AUD Index reached its highest level of 140.60 on April 2013, simultaneously with AUDJPY spike to 105.112. The massive drop in JPY clearly emphasizes and raises concerns on relative AUD strength. After all, Japan represents roughly 20% of Australia’s total trade volume.
At this stage, the RBA Governor Stevens aims 85 cents against USD, yet on trade weighted basis, such difference would be insignificant while the mid/long run outlook in JPY weakness remains. As per today’s computation, TW-AUD index would stand at 121.32 if AUDUSD stood at 0.8500 instead of 122.07; this is roughly 0.6% difference. On the other hand, AUDJPY at 105.00 would send the TW-AUD Index to 124.80, roughly 3% higher. From this angle, the future outlook is not favorable for more competitive Aussie, given the bearish expectations in Yen. Additionally to this, the PBoC efforts to inject two-way volatility in CNY trading to widen Yuan’s trading band should also favor AUD strength against its leading trade partner China, which represents approximately 30% of total trade volume as per today. Together, JPY and CNY stand for 50% of TW-AUD Index value, suggesting that the bearish view on the Yen and the Yuan should keep the upside pressures tight in AUD on trade weighted basis. It is just a matter of time before TW-AUD index sits back on top of the Fibonacci 61.8% on 2009-2013 increase (122.25).