China, Interest Rates, and AUD/USD

AUDUSD Hourly 090813Good Morning, Friends. The most convenient way I know to get a read on the market’s reaction to Chinese data is to glance at AUD/USD. Overnight, Chinese industrial production at large enterprises grew 9.7% year on year for July, a sharp improvement over June’s 8.9% report. This number fairly accurately tracks Chinese GDP, according to the “Financial Times”. This seemed like the sort of number that AUD/USD might respond to, since Australia is a major commodity exporter to China, and slowing Chinese growth, a drag on the Australian economy, has led the Reserve Bank into a string of rate cuts (supposedly finished, for now, unless they aren’t). 

The news was good for about 50 pips, nice, and certainly worth having, but hardly a game-changer. Were I short from the 1.05s since April – which, alas, I am not  – the blip overnight would not have cost me any sleep. The net effect, it seems to me, is to bring AUD/USD closer to a decent level for a new short entry, which on the daily chart looks to be around 0.9500, still some distance away. It’s possible to trade currencies in different timeframes, of course; there’s plenty of action available for those working with the hourly chart.

Of course, there are a lot of entities participating in the currency market, and a lot of their activity is commercial in nature, related to trade. The presence of these players creates quite a bit of noise, and the danger for those trading with shorter time horizons is that while a macro and technical view may be accurate, random price action can make holding a position untenable. Once stopped, it will of course snap back, because the market is malevolent, but knowing that doesn’t make it feel any better, at least in my experience. 

AUDUSD Daily 090813Academics and practitioners do agree on two things with regard to currencies. One is that they exhibit trending properties over time; as in the daily AUD/USD chart, once a move gets under way, it tends to keep going. Another, related, point of consensus is that over time a portfolio of currencies with higher interest rates will outperform a a basket of currencies with lower interest rates. Differing levels of inflation do not appear to alter this finding; a basket of currencies with high interest rates and comparably higher inflation will still outperform one of lower yielding currencies with low inflation. Real rates (that is, the return net of inflation), surprisingly, don’t appear to matter, or at least not enough to change the results dramatically. 

If that’s the case, then one of the better bets for currency traders is to identify central banks that are embarking on what are likely to be a series of rate cuts, and then short their currencies. AUD/USD is a case in point; as Chinese growth has slowed, the Reserve Bank has cut the benchmark interest rate several times, making holding the currency considerably less attractive for Japanese investors, in particular, who had been very fond of the short JPY/long AUD “carry trade”. With that said, entry levels remain critically important. Understanding the balance of demand and supply illustrated on the charts can and will make the difference between a sound entry that permits a long term, profitable trade to unfold and a poorly placed initial position that gets stopped out, even though the trader’s outlook was correct. 

It’s a Friday in August, and the E-mini futures are down a bit. I don’t expect to do much trading today, but I’m constantly surprised. Best of luck with yours!