AUDUSD – Yield Trumps S&P Warning

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Market Drivers July 7, 2016

S&P Puts AU AAA on review
UK MP/IP better
Nikkei -0.67% Dax 1.12%
Oil $48/bbl
Gold $1368/oz.

Europe and Asia:
EUR GE IP -1.3% vs. 0.0%
GBP UK IP 1.4% vs. 0.5%

North America:
USD ADP 8:15
USD Weekly jobless 8:30
USD Building Permits/Starts 8:30
CAD Ivey PMI 10:00

It’s been a relatively calm session in overnight FX trade today with commodity dollars continuing to attract investor demand as both Aussie and kiwi set fresh session highs by mid morning London dealing.

The Aussie saw sharp turnaround after tumbling in early Asian session trade on announcement by the S&P that it was downgrading the country’s AAA debt to negative from stable. The S&P cited the current impasse in Australian politics as a key factor weighing on the country’s finances as it grapples with controlling its fiscal deficit.

Although the results from the latest Australian election have yet to be fully tallied it appears that the current Coalition party will fall short of simple majority in the Parliament forcing it to rule as minority government making it more difficult to close the gap in fiscal finances.

In its assessment the S&P noted that, ”The negative outlook on Australia reflects our view that without the implementation of more forceful fiscal policy decisions, material government budget deficits may persist for several years with little improvement. Ongoing budget deficits may become incompatible with Australia’s high level of external indebtedness and therefore inconsistent with a ‘AAA’ rating.”

The Aussie quickly tumbled to 7470 in the wake of the release, but then just as quickly recovered as investors shrugged off the warning and resumed buying the unit. By midday London AUD/USD was trading above 7530 as all traces of the dip were erased. The demand for Aussie as well as kiwi has been directly proportional to the drop in yields across the G-7 universe. With some much of sovereign debt now trading below zero yield and with short term rates essentially nonexistent the 1.75% yield offered by the Aussie is simply too tempting for carry traders and the markets are willing to take the credit risk in order to capture the excess basis points.

Although some analysts were worried that the S&P action may prompt the RBA to consider further easing in August, that scenario appears unlikely especially if next week’s AU labor numbers continue to show steady growth. Therefore until AUD/USD short term yields come under threat of being lowered the currency will remain bid with .7600 the next target of the longs.

In North America today the market will get a look at the ADP data which is expected to show 160K new jobs in June. If the number comes in anywhere near the estimate it should provide some support for USD/JPY as it will be the second key release to suggest that US job growth rebounded after a surprisingly weak May reading. A positive ADP number should also provide a better backdrop for risk appetite and could help drive both equities and comm dollars higher as the day proceeds.

Boris Schlossberg
Managing Director

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