Australian Dollar 'Flies' as China's Xi Soothes Worries Over Global Trade

- AUD/USD collapse averted as multi-year trend line holds. 

- GBP/AUD advance halted by a conciliatory Xi Jingping.

- Bond market dynamics matter most for medium term trajectory.

Image: Xi Jinping © GovernmentZA, image Reproduced Under CC Licensing

The Australian Dollar staged a rebound against its developed world rivals during the morning session in London Tuesday, April 10 drawing a line beneath Monday's losses, as traders' concerns over a possible trade war between the world's two largest economies were eased by a conciliatory speech from Chinese President Xi Jingping.

The renewed risk-on tone prompted by the speech typically benefits the Australian Dollar so it is little wonder the currency is one of the better performers of the day. "Commodity currencies made a comeback Tuesday as global trade tensions cooled. China’s president spoke in a largely reassuring tone, saying the world’s No. 2 economy would cut tariffs in Chinese imports of automobiles. Trade-sensitive currencies from Canada, Australia and New Zealand rallied to fresh multiweek peaks," says Joe Manimbo, a currency analyst with Western Union.

Speaking at the annual Boao Forum for Asia conference, Xi told an audience that China will work harder to open up its economy to the rest of the world, which could include a relaxation of tariffs on car imports from the rest of the world. Most importantly, Xi pledged to strengthen legislation designed to protect intellectual property and avoided any harsh rhetoric toward the White House.

"A White House official who watched the speech has stated that the reference to autos appeared to be an opportunity to develop trust between the two sides. From this perspective, the speech has provided some short-term relief for financial market participants, who have become increasingly concerned over the risk that building trade tensions between the US and China could escalate into a full blown global trade war," says Lee Hardman, a currency analyst with MUFG, the world's fifth largest bank by assets.

China says it will take the initiative to expand imports this year and made clear its desire to achieve a greater balance of international payments under the current account.

Jinping also urged developed economies to stop imposing restrictions on what he described as normal and reasonable trade of high-tech products and to relax export controls on this trade with China, emphasising that countries should "stay committed to openness, connectivity and mutual benefits".

Australia's Dollar, which is among the most sensitive in the developed world to changes in the market's appetite for risk, rose broadly against all other G10 currencies in response to the speech. The AUD/USD rate was 0.35% higher at 0.7725 during the morning session Tuesday while the Pound-to-Aussie rate was 0.18% lower at 1.8321. 

"Momentum has turned bullish. Market players seem to be in a wait-and-see mode, monitoring how the trade spat between the US and China will turn out. This pair may hover within the 0.7640-0.7740 range for a while with bulls capped by US-China trade tensions," says Saktiandi Supaat, an FX strategist at Maybank in Singapore, one of Malaysia's largest lenders.

Above: AUD/USD rate shown at weekly intervals. Captures multi-year uptrend in the pair.

Tuesday's move, at least temporarily, draws a line beneath steep losses seen at the beginning of the month, which previously had the Australian Dollar threatening to break below a multi-year upward sloping trend line against the US Dollar.

It has also spared the Antipodean currency from plumbing the depths of new post-referendum lows against Pound Sterling. As we can see below, GBP/AUD now sits poised at just below the 1.85 level which appears to be acting as a strong resistance zone. 

Above: Pound-to-Aussie rate at weekly intervals. Captures post referendum recovery.

"While we are still a long way from a resolution of the current trade disputes and more negative headline news is very likely to follow (with the subsequent implications for risk assets), the risk environment should remain stable today with the likes of AUD and NZD outperforming while JPY lags its G10 peers," says Petr Krpata, chief EMEA FX strategist at ING Group.

As far as both the short and medium term outlooks go, analyst opinions around the Australian Dollar are highly polarised. With the Reserve Bank of Australia going nowhere fast, at a time when other central banks across the globe are raising interest rates, bond market dynamics are increasingly a challenge for the Australian Dollar.

The currency has historically been supported by government bond yields that have traditionally been higher than those of Australia's international rivals. However, two years of Federal Reserve rate rises have seen US interest rates reach 1.75%, leaving them 25 basis points higher than the 1.5% cash rate in Australia, which has now forced US government bond yields higher than those in Australia.

"It’s worth highlighting that the 2-year, 5-year and 10-year yield gaps are now at such extremes that US yields actually stand above their Australian equivalents, a situation not seen since 2000 when the AUD was trading closer to USD 0.5000," says Simon Derrick, chief currency strategist at BNY Mellon, in a note to clients.

This matters for currency markets because it means international investors now shun Australian bonds in favour of their North American counterparts, undermining a key driver of demand for the Australian currency in the quarters ahead. Only a change in Reserve Bank of Australia monetary policy can prevent this from weighing on the Aussie Dollar over the medium term. 

"AUD/USD has recovered through the 20 day ma at 0.7712, and continues to bounce just ahead of the 78.6% retracement at .7637 and the 2016-2018 uptrend line at .7623. The 200 day moving average offers initial resistance at .7812. Only a move above the 200 day ma would imply a rally to the .7840 short term channel top and beyond," says Karen Jones, head of technical analysis at Commerzbank.

However, as far as the short term goes, what matters most for the Australian Dollar is whether or not it can continue to hold above the multi-year trend line running from January 2016 to the present day. A decisive move below 0.7623 would mark a break of the long term trend and could pave the way for substantial declines not only in the AUD/USD rate, but also for the Aussie Dollar relative to other currencies. 

"The AUD has shown a marked propensity over the past 18 years for rapid and sustained moves. Over 10 instances of 20% y/y moves have developed for the AUD against the USD since the start of the new century," BNY's Derrick warned last week. "For the moment the two year-plus uptrend remains intact. However, should it break then the risk is that a particularly sharp move develops."

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