Given the rich natural resources in Australia, the Australian dollar has long been known to be levered to the global economic cycle. As shown in the chart above, the JP Morgan global PMI leads the Australian dollar by a three-month period. The relationship is clear: a thriving global economy, which presumably increases demand for resources in Australia, leads to better returns for Australian assets. Capital naturally gravitates to favorable conditions. Thus, a stronger global economy benefits the Australian dollar, and vice versa. This dynamic suggests potential upside for the Australian dollar, given improving economic data, even though the currency has yet to respond.

To further test this hypothesis, we can compare the performance of the Bloomberg Commodity Index with Australian Dollar futures. If a growing global economy truly drives increased demand for resources, this demand should manifest in higher commodity indices, which, in turn, should correlate with a stronger Australian dollar. However, we observe a dislocation: the commodity index has risen throughout the year, while Australian Dollar futures have moved in the opposite direction. Should this historical relationship hold, it would also suggest higher Australian Dollar futures.

Whether due to cause or effect, the current weakness in futures prices is reflected in a rather weak-looking daily chart. The Ichimoku Cloud chart at the top shows both prices and the lagging span breaking below the cloud. With the RSI not oversold and the MACD in the bottom panel also suggesting further downside, the short-term outlook appears weak. However, the bottom chart offers a potentially more optimistic view. The five-year downtrend seems to be flattening, as the cloud moves laterally, hinting at a possible trend reversal.. Prices are entering the cloud and threatening a breakout soon, with the lagging span also nearing a breach of the cloud, which would signal a change in trend. Thus, while short-term prices are weak, the medium-term trend could be on the verge of changing, aligning more with improvements in the global economy and commodity prices.

The top chart shows muted implied volatility in FX markets this year, with the G5 FX index near multi-year lows. However, Australian dollar implied volatility recently rose, possibly due to falling futures prices.  Traders may be adding to long volatility positions, hoping for more volatility. The bottom chart of the skew ratio corroborates this: the G5 FX market’s preference for upside vs. downside options is flat at a 1. In contrast, the Australian dollar has shown a more consistent preference for downside options all year, recently hitting multi-year lows, indicating a strong preference for puts over calls.

The primary catalyst for the Australian dollar in the coming weeks is the Reserve Bank of Australia (RBA) meeting on November 3. Despite its prominence, the market shows little concern, with the top chart, using the Event Volatility Calculator, indicating no volatility priced into this meeting. Further, the implied volatility for November 3 is lower than the surrounding dates, suggesting no expected outsized movement, as no rate change is anticipated.  However, a December rate cut is expected, and central bank commentary could still cause movement. The volatility surface also shows higher implied volatility in puts (downside options) vs. calls, aligning with the lower skew ratio. Both the benign pricing for November 3 and higher put volatility could offer opportunities for traders seeking a countertrend move.

Considering all factors, an interesting scenario emerges for those who believe the strength in the global economy and the commodity markets could lead to upside in Australian Dollar futures. While short-term daily charts show weakness,  weekly charts indicate potential bottoming from a multi-year trend. Combined with improved fundamentals, any dip in futures could be an opportunity to go long. The options market offers an intriguing way to capitalize on this view.

Given low overall volatility l and higher demand for puts vs. calls, traders can find a better way to express a countertrend move higher in futures. Consider the MA1X5 expiration, the November 3 contract expiring after the RBA meeting. Selling 0.6400 downside puts yields enough premium to buy twice the number of 0.6625 calls, creating a  zero-cost structure. This means no profit or loss between 0.64 and 0.6625 at expiration. The structure profits significantly on a large upward move and only loses on a substantial downward move, with double the profit potential above the strike. If economic data improves and/or the RBA signals slower easing, the Australian dollar could bottom, leading to a weekly chart breakout and trend change, which this structure can leverage from a risk management perspective, traders should be aware that losses begin below 0.6400 at expiration and plan accordingly.

The daily expirations in the Australian Dollar options market offer flexible and creative ways for traders to leverage their views on upcoming calendar events.

Good luck trading!

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