- Hedge funds and asset managers are positioned for the Australian dollar to underperform the U.S. dollar, but these positions could be vulnerable to China positivity and RBA resilience.
- CME data on option strikes suggests demand for upside strikes in AUD/USD beyond 0.69. Second-quarter inflation will prove critical for the Australian dollar’s path in coming months.
- The FX volatility curve using CME options data suggests investors are no longer in “fear” mode.
The Australian dollar has fluctuated considerably this year. Originally supported by the prospect of a strong China recovery, AUD rallied 4.8% against USD before a small financial crisis sent the currency nearly 8% lower. Recent price action has been similarly volatile, with positive developments in China battling a dovish take on labour force data from the Reserve Bank of Australia (RBA) that forced investors to pare hiking expectations.
These conflicting factors have forced investors to position carefully. Hedge funds have flipped net-short on the Australian dollar from net-long a month ago (Chart 1). Only the pound and Canadian dollar have seen larger changes, both to an extreme size: hedge fund GBP net-longs outnumber any other net-long positioning while hedge fund Canadian dollar net-shorts are only second to yen net-shorts.
Meanwhile, asset managers have pared Australian dollar net-shorts, the largest positioning shift towards any currency (Chart 2). They also added to yen net-shorts, though hedge funds remain in larger yen net-shorts. Lastly, they pared some of their extreme euro net-longs.
Aggregating investor positioning, we find hedge funds and asset managers are both net-long the pound and both net-short the yen, Australian dollar, and Canadian dollar. However, they hold conflicting views on the euro and Swiss franc.
Macro Hive take: We hold the opposite view on the Australian dollar. Global economic data is holding up, supporting commodity price action, while China’s second attempt at reopening is underway–this time with fiscal stimulus. Meanwhile, Australian inflation is proving stickier than expected. Therefore, the Australian dollar could outperform versus market expectations and even against USD.
AUD/USD has traded 1.3% higher from Q2 2023 lows, having previously fallen 4.3% from Q2 2023 highs. Now withdrawing from a technical floor at 0.66, it must overcome the next obstacle–bearish FX options positions. According to CME data on option strikes:
- There is notable net demand for AUD/USD puts from 0.67 to 0.69 (Chart 3). Additionally, there is another bout of bearish demand between 0.62 and 0.645.
- However, above 0.69, support is plentiful; there is notable net demand for AUD/USD calls from 0.69 upwards, with demand failing to settle until 0.71 onwards.
What to watch: China fiscal stimulus remains pivotal to the direction of the Australian data, so news on that front could easily propel the currency in either direction. Meanwhile, continued RBA hawkishness could support the currency. Consequently, second-quarter inflation (26 July) will prove pivotal as it could confirm sticky services inflation.
FX investor risk appetite
CME has a range of FX volatility data to help investors track the level of volatility. We can also use FX volatility data to determine investor risk appetite. We find the shape of the FX volatility curve useful in this regard. When shorter-dated FX implied volatility is higher than longer-dated volatility, this suggests investors are worried or in panic mode. In contrast, when shorter-dated FX volatility is lower than longer-dated volatility, this suggests investors expect calm markets. The latest data finds:
- FX volatility curve inversion continues, though it has retraced (Chart 4). Calm has lessened as investors acknowledge the Federal Reserve raising interests beyond market pricing. This suggests investors are no longer in total comfort.
- The move aligns with the CVOL volatility indices, which have followed a similar dynamic, picking up from lows in June.
- Outside FX, equity volatility has stabilised at historically low levels, while rates volatility remains historically elevated despite being pared from 2023 extremes.
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