A currency pair for the recovery

A pair for the recovery

What currency pair is poised to bounce back in the recovery? Since the start of the Coronavirus, the Australian Dollar has depreciated sharply against the US Dollar. However, history has shown to repeat itself in regards to economic shocks and this currency pair.

During the 2008 Financial Crisis, the AUD/USD pair followed a somewhat explainable trend – it depreciated at the peak of the recession and appreciated once economic activity and the recovery started in mid-2009.

Whats the big driver for the Australian Dollar?

The Australia Dollar has been considered by most as a commodity currency – in that it tracks the price of the commodities it exports – mainly iron, copper, and coal. In economic downturns like the one we are currently facing and 2008, manufacturers who use iron and copper tend to slow down their production or halt it together. Lower demand for iron and copper not only implies a lower price for said commodities, but it also means fewer exports from Australia, therefore less demand for the Australian Dollar.

If we take into account that investors tend to decrease their exposure in risky assets and safer assets such as the US Dollar, Treasuries, and Gold, there is a compounding effect on the AUD/USD as there is less demand for the AUD and an increase in demand for USD.

Is the road to recovery in sight?

The thesis of a long AUD trade hinges on one fundamental question – do we see a recovery in sight? A difficult question, as it implicitly asks to predict a bottom in the stock market, productivity, and in this case – the effects of the Coronavirus. Signs of an economic recovery are showing, albeit tentatively. Countries are slowly emerging out of lockdown, oil inventory buildup in the United States was 2.7m less than predicted, and there have been talks of creating “mini bubbles” with countries. But, if we take a look historically at what the market movements have been in the previous recession.

A similar pattern emerges

After the initial drop in 2008, there was a short bull period before another further drop in prices in early 2009. A similar pattern can be seen in the 2000 – 2005, following major events such as the dotcom burst, the September 11 attacks alongside the further correction in 2002. If history repeats itself, we may likely see a similar pattern in the following months. Talks of a “second wave” of coronavirus cases, alongside earnings season and muted demand across all sectors may be the catalyst for a drop asset prices.

It is clear that the AUD/USD pair appreciating is contingent on manufacturers dependent on their exports restarting production. An implicit proxy for this is the directional trend of the market. As stated above, history shows that there may be another depreciation in the Australian Dollar and the market. However, history also shows that once manufacturing activity does restart, the Australian Dollar is likely to appreciate. Furthermore, headwinds for the Australian Dollar include extensive quantitative easing and expansionary fiscal policy in the United States, which has historically driven the US dollar down.

Is it time to think about a position in the Australian Dollar?

Here is Anish Lal on his short term analysis on the recovery of the Australian Dollar and the ASX in light of geopolitics. Watch the video hereOr alternatively, click the thumbnail below,

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