In today’s article, we will describe some specific economic events that affect the Aussie Dollar and how traders can use these events to trade the AUDUSD currency pair. Very often, traders are confronted with the choice of what to trade when a news release hits the markets. It is important to understand that not every currency is suited for trading certain news releases. By knowing what to trade and what currencies to use when trading certain news releases, traders can increase their success rates when trading the news.
One unique feature of the AUDUSD is that it is a currency pair that has a very predictable and direct response to most of the news releases that impact it. So if a news release has a positive or negative influence on the AUDUSD, then we will see the AUDUSD either going up or down in a very clear and unambiguous manner. This makes the Aussie Dollar a very good currency with which to trade news events from the economic news calendar.
China and the AUD/USD
40% of the world’s production is done in China. To fuel this activity, China has to import resources and raw materials to fuel this industrial engine, and then export the finished goods to the rest of the world. Economic news coming out of China has therefore assumed economic significance in the last few years. Most of China’s key imports will come from Australia. The AUD/USD will therefore be a currency of choice when trading economic news from China. But what is the relationship between the AUD/USD and China, and what makes this currency pair a very good choice for trading news out of China?
The answer lies in the relationship between the commodity markets and global growth. Australia is a prime example of a commodity market, and the AUD a commodity currency. 40% of the world’s production comes out of China. Most of the consumption of commodities that constitute raw materials (solid minerals and crude oil) is largely accounted for by China. A large percentage of consumer goods used today the world over also comes out of China. For these reasons, China represents a country that can be used as an index of global growth or global slowdown.
Increased growth in China, will trigger greater demand for Australian exports, which in turn will drive the value of the Aussie Dollar upwards. So the next question would be: what constitutes growth or an expectation of growth as far as the Chinese economy is concerned?
- Chinese GDP
- Chinese inflation data (CPI and PPI)
- Commodity prices
- Interest rates (initially).
How are all these factors interwoven? An increase in the Chinese GDP will spur growth, which fuels demand for commodities from Australia and lead to higher commodity prices. Growth also puts more money in the hands of its citizens and therefore leads to inflationary pressures on the economy. This will cause the government of China to raise interest rates. The sum total of these figures would be an increase in the value of the AUD/USD.
Conversely, lower Chinese GDP will lead to lesser demand for commodities from Australia, a fall in commodity prices and reduced inflationary pressure, which keeps interest rates stagnant or even lower. These factors will lead to a reduction in the value of the AUDUSD.
Let us take a look at the response of the AUDUSD to some of the fundamental triggers coming out of China in the recent past.
The Chinese News Data
The following data coming out of China are a constant presence in the economic news calendar:
- Chinese CPI
- HSBC Flash PMI
- China Trade Balance
We now describe how these three news data affect the Aussie Dollar and how they can be used to trade the AUDUSD.
Consumer Price Index (CPI)
The Chinese CPI is usually of greater importance than the Producer Price Index (PPI) when it comes the Chinese inflation data. Released by the Chinese National Bureau of Statistics, the CPI measures the change in the price of goods and services purchased by consumers. The next release is scheduled for Saturday March 8, 2014.
The Chinese CPI will affect currency valuation because rising consumer prices will cause the Chinese central bank to consider raising interest rates. This we have identified in the introductory paragraphs, is a positive move for the AUDUSD. Let us see how the currency pair reacted to the most recent Chinese CPI results.
On the morning of February 14th, 2014, the Chinese CPI figures came in at 2.5% higher than it was the previous year. The expected figure had been 2.4%. Higher inflation will make a central bank consider interest rate increases. This increase in the CPI is something that would therefore favour an increase in the value of the AUD/USD. The Aussie indeed rose 0.42 percent to an intraday high of 0.9025 against the US Dollar. We see this in a snapshot of the AUDUSD taken at the time of the news trade. Over a space of 6 hours, the Aussie rose from 0.8977 to 0.9025, for a move of 48 pips.
HSBC Flash China Manufacturing PMI
The HSBC Flash China Manufacturing PMI is one of the most powerful Chinese economic indicators that affect the AUDUSD. This economic indicator measures the level of a diffusion index based on surveyed purchasing managers in the Chinese manufacturing industry. This piece of news is released on a monthly basis (usually in the 3rd week of the month) and the next release is scheduled for March 23, 2014. So this is a piece of news you need to watch out for later this month.
The baseline is set at 50.0. A figure above 50.0 indicates an expanding manufacturing industry, which will fuel an increase in demand for raw materials from Australia, boost the Australian economy and therefore lead to a rise in the value of the AUDUSD. A figure below 50.0 is a sign of a contraction in the Chinese manufacturing industry, which is not pleasant news to the Australian economy as demand for its exports will drop off and lead traders to dump the Aussie Dollar.
Two versions of this report are released, usually about a week apart from each other. These are the Flash Manufacturing PMI and the Final Manufacturing PMI. The Flash version of this news comes out before the Final version, and so exerts more market impact.
It’s a leading indicator of economic health – businesses react quickly to market conditions, and their purchasing managers hold perhaps the most current and relevant insight into the company’s view of the economy.
How does the AUDUSD react to the release of the HCBC Flash China Manufacturing PMI? The chart below is a typical response of the AUDUSD to the direction of the figures for this news release. In this example, the figure came out at 48.3, compared with the expected figure of 49.4. The previous figure was 49.5, leaving a deviation of 0.1. The difference between the actual figure and the expected figure was -1.2, which made this news item very tradable. We can see the bearish response of the AUDUSD to this news release:
This figure was a seven-month low as far as this news report is concerned, and was responsible for the 61-pip drop in the value of the AUDUSD as seen on this chart.
Chinese Trade Balance
The trade balance of any country is the difference between the value of imports and the value of exports of that country during the previous month. This news item was released on the 7th of March; we will analyze this trade later on.
Even though the news release emanates the Customs General Administration of China (CGAC), the data is denominated in US dollars. A positive number (a surplus) is seen when the value of exports exceeds that of imports. A trade deficit occurs when a country’s imports outweigh the exports.
The trade balance data comes with several parameters, and it is important to look at the parameters closely. Generally speaking, the demand for exports is directly correlated with the demand of the currency of the exporting country. But more importantly, for a country like China, traders would like to see the country import more products. These products will include imports from Australia, which would cause the Australian Dollar to rise in value as a result of the cascade mechanism we have described above. But then, a country which is also exporting more will have a growing economy and increasingly thirsty industries which will demand more raw material imports. So in essence, it is not simply enough to say that if China has a trade surplus or a trade deficit, then the Aussie Dollar would sway one way or the other.
It would rather make more sense to look at the figures in context, comparing them with previous figures and also looking at the individual parameters. We now use the example of the February trade balance report to illustrate this point.
- China trade balance for January: $ 31.9bn (expected +$23.45bn, prior was $25.64bn)
- Exports for January: 10.6% y/y (expected +0.1% y/y, prior was +4.3% y/y)
- Imports for January: 10.0% y/y (expected +4.0% y/y, prior was +8.3% y/y)
The AUD/USD jumped 46 pips on the news release which showed better than expected trade balance results. In this result, we see that exports and imports BOTH jumped up above the expected figures. This situation where exports from China and imports to China were increasing is a sign of a continuously positive cycle of imports fuelling the Chinese industries to export products, increasing the revenue base and growth of the manufacturing sector in China and expanding their capacity to take in more imports.
OTHER ECONOMIC DATA OF IMPORTANCE TO THE AUDUSD
A host of other economic data will also have a profound effect on the Aussie Dollar, setting up several different ways to trade the AUDUSD.
a) AUD/USD and Copper
In the last few years, there has been a very strong correlation between copper prices and the value of the Aussie Dollar. At a point, this correlation was as high as 93%. Copper accounts for AUD$5 billion of the annual trade volume of Australia. China’s industries consume a lot of copper, and they naturally get this from Australia. Economic data, especially those which affect manufacturing will therefore impact copper prices and the AUDUSD. Divergence trades on copper and the AUDUSD can be used to pick out trading opportunities. Since copper is expected to follow the direction of the AUDUSD and vice versa, a situation where the AUDUSD is divergent from price movements of copper will create trading opportunities. Our emphasis is on the Australian Dollar, therefore the trade to make would be to note the direction of copper, and then trade the AUD/USD in that direction. This trade would stay valid for as long as copper and the AUDUSD are correlated.
AUDUSD and Gold
Gold is used as an alternative investment in times of uncertainty of market returns. Gold is also used as a hedge against inflation, and we all know that inflation erodes the purchasing power of a populace. Therefore, it can be said that whenever there are expectations of interest rate increases to curtail inflation, we tend to see greater demand for gold.
Australia is the world’s largest producer of gold, and an increase in the demand for gold in response to global uncertainty or in anticipation of inflationary pressure would lead to an increase in the value of the AUDUSD. Conversely, when demand for gold drops off and gold prices tank, we see the AUDUSD going along with it.
AUDUSD and the Carry Trade
In the early part of the last decade up until 2006, the GBPJPY was the perfect example of a carry trade strategy at work. With an unmatched interest rate differential between both economies, the British Pound and Japanese Yen were a carry trader’s dream. This all came to a halt when the global financial crisis forced central banks all over the world to cut interest rates in a coordinated fashion to stimulate the growth of their economies.
As the world shows signs of economic recovery, central banks are gradually winding up the stimulus programs and tightening of rates is no longer such a futuristic event as it was three years ago. Thus the return of the carry trade opportunity for discerning traders is now a reality.
Presently, the JPY, CHF and USD carry the lowest interest rates of the commonly traded currencies, while AUD and NZD have the highest interest rates. The carry trade strategy involves selling low interest yield currencies and then buying high interest yield currencies. The AUDUSD is thus appropriately positioned for this. An article has been written by me on this blog about the carry trade strategy. You will do well to review that piece.
In conclusion, it is pertinent to remind traders that a number of key economic data will affect the AUDUSD in 2014 and beyond. Some of these economic data are as follows:
- Interest Rate Expectations: Interest rate expectations are the key drivers of currency-pair price action. When interest rates are expected to rise, the currency pair will become more attractive and therefore attract demand. The general effect is the pair increases in value.
- Relative Growth: If one country is growing faster than another, the currency of the stronger growth country will tend to be stronger as it attracts capital.
- Data Releases: Currency pairs are extremely sensitive to economic data releases. Disappointing GDP results in a weakening of the currency. Surprise positive data generally increases the value of the currency.
- Resistance and Support: These daily and weekly levels are important for currencies as $5 trillion a day is exchanged; intraday movements are subject to noise trading and not that meaningful.
- Commodity-based currency pairs: The AUD/USD is the main commodity-based pairs and move in reaction to commodity markets.
The author’s views are entirely his or her own.