Sunday, December 16, 2012

What's spooking AUD shorts?

A number of trades who have shorted the Australian dollar due to weakening fundamentals (see post) are capitulating. The net non-commercial positions on the CME reached a new all-time high.

Source: CFTC

And the CFTC data clearly shows that this increase in the net is mostly due to shorts getting out of their positions (rather than from longs adding to positions). What's spooking the shorts? Here are some thoughts:

1. The recent pickup in China's economic activity (see discussion) could cushion weakening Australian economy.

2. Related to that, China's demand for steel has picked up somewhat, as steel and iron ore inventories decline (see discussion). Steel prices in China have firmed up as a result, which in turn lifted iron ore prices. That may provide some support to Australia's mining industry.

Steel Rebar Futures on SHFE

3. The RBA has taken a surprisingly hawkish approach, which reduces the probability of the central bank pushing the overnight rate below 3% (see discussion). In fact the central bank has been critical of its counterparts in the EU, the US, and Japan for excessive monetary expansion (see discussion).

4.  Being short AUD against USD (using an FX forward for example) costs almost 300bp/y of negative carry due to the rate differential between the two currencies. Plus the Fed's actions to dramatically expand the monetary base makes some traders uneasy with being long the USD.

5. Technically AUD is near a resistance level, which if broken, could send AUD higher.

Ironically, this AUD strength is going to keep the Australian economy from significant improvements (and could in fact weaken it further) - at least in the near term. Strong Australian dollar continues to plague Australia's export sector, which competes with nations who have successfully depreciated their currencies on a relative basis (see discussion).
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