Inflation not down under!
Australia's CPI data, released yesterday, showcased figures hotter than anticipated. While this may not be 'reaction-worthy' news on its own, the scenario in Australia is worth delving into for several reasons.
Inflation Trends
Initially, let's consider inflation trends. In most western economies, although inflation remains above central bank targets, the trends are on a downward trajectory. However, when juxtaposed against those for the European Union (EU) and the United States (US), Australia's (AU) inflation rates on a month-over-month (MOM) and year-over-year (YOY) basis still stick out from the norm.
Moreover, yesterday’s CPI prints surpassed consensus on both the YOY & MOM basis, indicating a notable deviation from expectations.
In fact, Australia's YOY CPI is now on its longest streak above inflation expectations, and crucially, inflation expectations have ceased revising downwards.
Given the higher inflation levels compared to its peers, consensus estimates, and expectations, inflation remains a significant concern for Australia.
Interest Rates
In the realm of interest rates, Australia has been a long-standing “pauser,” having maintained its policy rate unchanged since its June meeting. This prolonged pause now further opens the leeway to raise rates, especially given the “watch and see” approach adopted towards burgeoning inflation. Additionally, its interest rates remain low compared to the US, EU, Canada, and even New Zealand.
As a result, on the real rates basis, Australia trails far behind, with its policy rate still 1.3% behind its inflation rate, significantly less restrictive compared to other economies that have already moved into positive real rates territory.
We posit that the RBA is behind the curve and has room to react, given the considerably long period of pause and still negative real rates.
The market seems to echo this sentiment too, as the odds for a hike in the next meeting surged post the CPI news, moving from 21% to 55%!
Against multiple currencies, the AUD appears to be threading above the long-term support level, a threshold that has essentially defined AUD low. This strong support is expected to hold, given its tested and respected level across multiple currency crosses since 2020.
Policy turning points between the two currencies, as indicated by the turn in the interest rate differential, have generally marked the trend change for the currency, notably for the AUDEUR pair.
Given the persisting high inflation in Australia compared to various economies and metrics, should market expectations trend in the right direction, it's plausible the Reserve Bank of Australia (RBA) may react with a rate hike. This action could tilt the rate differential and interest for the AUD, bolstering the currency.
To capitalize on this bullish view on the AUD, we can consider a long position on the AUDEUR. We can set up this trade via a long position on the CME Australian Dollar Futures and a short position on the CME Euro FX futures to create a synthetic long AUD/EUR position at the current price level of 0.5951, stop at 0.5865 and take profit at 0.615.
Given that one CME Euro FX futures is for 125,000 Euros and one CME Australian Dollar Futures is for 100,000 Australian Dollars, this suggest that we should use two Australian Dollar Futures to one Euro FX Futures to match the contract size, given that 125,000 Euros is roughly equivalent to 210,000 Australian Dollars at the prevailing exchange rate. Each 0.00005 increment in the Australian Dollar Futures is equal to 5 USD and each 0.00005 increment in the Euro FX Futures is equal to 6.25 USD.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Reference:
cmegroup.com/markets/fx/g10/australian-dollar.contractSpecs.html
cmegroup.com/markets/fx/g10/e-micro-australian-dollar.html
melbourneinstitute.unimelb.edu.au/publications/macroeconomic-reports/latest-news/survey-of-consumer-inflationary-and-wage-expectations
rba.gov.au/statistics/cash-rate/
asx.com.au/markets/trade-our-derivatives-market/futures-market/rba-rate-tracker
cmegroup.com/markets/fx/g10/euro-fx.contractSpecs.html
Inflation Trends
Initially, let's consider inflation trends. In most western economies, although inflation remains above central bank targets, the trends are on a downward trajectory. However, when juxtaposed against those for the European Union (EU) and the United States (US), Australia's (AU) inflation rates on a month-over-month (MOM) and year-over-year (YOY) basis still stick out from the norm.
Moreover, yesterday’s CPI prints surpassed consensus on both the YOY & MOM basis, indicating a notable deviation from expectations.
In fact, Australia's YOY CPI is now on its longest streak above inflation expectations, and crucially, inflation expectations have ceased revising downwards.
Given the higher inflation levels compared to its peers, consensus estimates, and expectations, inflation remains a significant concern for Australia.
Interest Rates
In the realm of interest rates, Australia has been a long-standing “pauser,” having maintained its policy rate unchanged since its June meeting. This prolonged pause now further opens the leeway to raise rates, especially given the “watch and see” approach adopted towards burgeoning inflation. Additionally, its interest rates remain low compared to the US, EU, Canada, and even New Zealand.
As a result, on the real rates basis, Australia trails far behind, with its policy rate still 1.3% behind its inflation rate, significantly less restrictive compared to other economies that have already moved into positive real rates territory.
We posit that the RBA is behind the curve and has room to react, given the considerably long period of pause and still negative real rates.
The market seems to echo this sentiment too, as the odds for a hike in the next meeting surged post the CPI news, moving from 21% to 55%!
Against multiple currencies, the AUD appears to be threading above the long-term support level, a threshold that has essentially defined AUD low. This strong support is expected to hold, given its tested and respected level across multiple currency crosses since 2020.
Policy turning points between the two currencies, as indicated by the turn in the interest rate differential, have generally marked the trend change for the currency, notably for the AUDEUR pair.
Given the persisting high inflation in Australia compared to various economies and metrics, should market expectations trend in the right direction, it's plausible the Reserve Bank of Australia (RBA) may react with a rate hike. This action could tilt the rate differential and interest for the AUD, bolstering the currency.
To capitalize on this bullish view on the AUD, we can consider a long position on the AUDEUR. We can set up this trade via a long position on the CME Australian Dollar Futures and a short position on the CME Euro FX futures to create a synthetic long AUD/EUR position at the current price level of 0.5951, stop at 0.5865 and take profit at 0.615.
Given that one CME Euro FX futures is for 125,000 Euros and one CME Australian Dollar Futures is for 100,000 Australian Dollars, this suggest that we should use two Australian Dollar Futures to one Euro FX Futures to match the contract size, given that 125,000 Euros is roughly equivalent to 210,000 Australian Dollars at the prevailing exchange rate. Each 0.00005 increment in the Australian Dollar Futures is equal to 5 USD and each 0.00005 increment in the Euro FX Futures is equal to 6.25 USD.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Reference:
cmegroup.com/markets/fx/g10/australian-dollar.contractSpecs.html
cmegroup.com/markets/fx/g10/e-micro-australian-dollar.html
melbourneinstitute.unimelb.edu.au/publications/macroeconomic-reports/latest-news/survey-of-consumer-inflationary-and-wage-expectations
rba.gov.au/statistics/cash-rate/
asx.com.au/markets/trade-our-derivatives-market/futures-market/rba-rate-tracker
cmegroup.com/markets/fx/g10/euro-fx.contractSpecs.html
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