Red Everywhere, Watch AUD/JPY for As a Guide

The known challenges to the markets, namely the spread of the Delta variant, rising inflation, and the Fed policy outlook have suddenly exploded into life. It’s all in timing some might say, which is especially true in trading.

The single Covid case in New Zealand set off alarm bells everywhere, with the Ardern government swiftly ordering a national lockdown due to its “zero Covid” strategy. Going hard and early instead of light and long has proven to have far less of an enduring economic impact. But the RBNZ was forced to delay its planned route to policy normalisation, even if it did surprise more hawkishly on its future rate projections.

Fed set to reduce the punchbowl

With global growth forecasts being re-rated on disappointing China data amid rising Delta variant cases, we’ve also heard from Fed officials who are now ready to taper before the end of this year. Sufficient progress has been made towards the inflation target and progress is being seen towards the FOMC’s employment goal.

Remember that the bumper July payrolls came after the Fed minutes, so a solid August report is probably good enough to announce a tapering framework potentially at the September meeting. With consensus veering towards a faster taper too, an end date around the middle of next year could be on the cards, paving the way for a rate rise by the end of 2022. This has certainly given the equity bulls some jitters, even if bond market consensus was spot on. Of course, increased volatility and Delta variant concerns may be a factor going forward.

Aussie’s perfect storm

Risk-taking is on the back burner for now, which means high beta commodity currencies like the Aussie are in a world of pain. The worst performing major this month, collapsing commodities, and plunging iron ore prices need to be added to the list of drivers hurting AUD. Similarly, the global bellwether copper has fallen every day this week until today and is now touching the 200-day moving average. This has pushed the RBA far down the list of major hawkish central banks, highlighted by their recent minutes which hinted at a much more dovish debate under the surface.

AUD/JPY global risk gauge

This currency pair is viewed as the best risk barometer and a metric for measuring broader sentiment is AUD/JPY, even if the historic positive correlation with US equity markets has decoupled since mid-June. The woes of the Aussie are well known, while the yen has also been getting a decent tailwind from falling US Treasury bond yields. The pair is making new year-to-date lows again today after slipping below the July low at 79.84 and the January low at 79.20. Next support comes in around 78 and the 38.2 Fib retracement level.

We are on for seven days of losses now and prices are oversold on the daily RSI and have scythed through the lower Keltner band. This warns of a pullback, though buyers will need to get back above 80 to slow the strong bearish momentum.

Written on 20/08/2021 by Lukman Otunuga, Senior Research Analyst at FXTM

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