In our last commentary on the Australian dollar, we wrote that the currency was an enticing short opportunity thanks to slowing Chinese growth and a bearish trend. Specifically, we recommended shorting AUD/USD as means to express a bearish view on the currency. Since that time, the pair has weakened (from 0.7560), and is trading around 0.7280 on August 13.  

Going forward, we see further declines in the Australian dollar against the US dollar. While some domestic economic indicators are rebounding, we expect decelerating Chinese growth, the associated weakness in commodities, and an ongoing rally in the US dollar to outweigh any positive domestic developments. Worsening US-China trade tensions (many are already calling it a trade war) are also expected to weigh on the Australian dollar going forward.

Following epic stimulus program, Chinese growth set to keep decelerating

In early 2015, China embarked on a stimulus program in order to better manage its downturn at the time. Similar to its previous efforts, the government significantly expanded domestic credit and focused its efforts on physical infrastructure investments. As a big exporter of industrial commodities such as copper, coking coal and iron ore, the Australian dollar tends to rally in response to accelerating Chinese growth. An overview of recent trends in credit growth is shown below for reference:

China credit: here comes the hangover

Source: People’s Bank of China, CEIC, MarketsNow

As can be seen in the chart above, Chinese stimulus efforts (on a rate-of-change basis) peaked in early 2016. Unsurprisingly, early 2016 also marked a turning point for most commodities and emerging market financial assets. Given China’s big appetite for commodities, changes in Chinese growth have a significant influence on commodity prices.

Recent weakness in commodities also point to slowing growth

Beyond patterns in domestic Chinese credit growth data, market-based indicators of Chinese growth also suggest an oncoming slowdown. Given the strong relationship between future global growth and copper, the metal is often called “Dr. Copper” for its forecasting powers. Copper is especially useful for front-running changes in Chinese growth as more than half of the world’s copper production is destined for China. Historical copper prices and futures trading volumes are shown below:

Copper: The doctor’s prognosis is grim

Source: TradingView, MarketsNow

As can be seen above, copper prices took off in late 2016, lagging China’s big stimulus program by about a year. The metal then made a series of higher-highs until early 2018 (indicated above). While the industrial metal tried to make another higher-high in mid-June 2018, it ran out of steam and crashed down to around $2.75 per pound. Beyond failing to make a new high, the metal also made a lower-high around $2.87 in late July. This is a quantitative signal that copper is no longer in a bullish trend.

Beyond poor price-action, the recent sell-off has been accompanied by significant trading volumes. This is another bearish quantitative signal, and suggests that traders are selling the industrial metal with conviction.

While copper is followed closely for its forecasting track record, note that broader measures of commodity prices (such as the Dow Jones Commodity Index or the CRB index) have also entered a bearish trend in recent history. For a commodity currency like the Australian dollar, falling commodity prices are another negative factor going forward.

All hail the US dollar, the other side of the coin

Beyond slowing economic growth in China and recent weakness in commodity prices, the last factor weighing on the Aussie is the US dollar. In a recent commentary, we argued that the US dollar is expected to keep strengthening thanks to changing economic conditions. Specifically, we expect US growth to begin decelerating in rate-of-change terms thanks to the combination of steepening base effects and recent softness in forward-looking economic indicators. This is shown below for reference:

US growth: math catches up to you, eventually

Source: U.S. BEA, MarketsNow

As can be seen above, year-over-year US growth will have to contend with increasingly tougher comparables going forward. While the US historically achieved annual growth rates in the 5%+ area, this is no longer realistic today as economic indicators such as ISM sentiment figures and retail sales have all softened recently.

Growth outside the United States, in major regions such as the Eurozone and in China, has already been decelerating since the outset of 2018. Thanks to the arrival of a global downturn (occurring in all major economic regions of the world simultaneously) combined with a particularly acute slowdown outside the United States, we forecast significant strength for the US dollar going forward. While this is great news for US dollar-based investors, further strength in the US dollar will weigh heavily on the Australian dollar going forward.

Beyond the obvious primary impact, the Aussie will also have to cope with significant weakness in commodity prices and emerging markets assets that tend to accompany a surge in the US dollar. This explains why the Australian dollar can be so volatile, and sold off sharply during the 2008 global financial crisis and during the commodity/emerging markets downturn in 2015.

Australian dollar to remain in the firing line

While Australian dollar bulls may point to rate hike expectations and relatively strong domestic economic data, the harsh reality is that the Australian dollar is significantly correlated to commodity prices (and Chinese growth by extension). Chinese growth data, trends in commodity prices and global economic conditions all point to a lower Australian dollar (especially against the US dollar) for the foreseeable future.

In terms of trading opportunities, AUD/USD is currently trading near the bottom-end of its daily trading range. We recommend shorting the pair towards the top-end of its trading range.