The pound has risen for seven consecutive days against the Aussie dollar, and whilst it is looking overstretched, there are no signs from indicators that it is overbought.
The RSI indicator is still below the overbought zone, and MACD has actually broken above the key zero-line which distinguishes an up-trending market from a down-trending market.
There are no signs the pair is about to stall and so an extension of the current upside remains the preferred base case scenario going forward.
A move above the current highs, including a small margin, so above 1.9260 would probably be sufficient to confirm the extension of the short-term up-trend higher to the next line of defence at 1.9370, made up of an old trend-line and the R1 monthly pivot, both of which would be expected to slow down the rally, and possibly initiate a correction.
As a result of several fundamental factors, the outlook for the Australian dollar have been down-graded markedly over recent days.
Inflation data for the March quarter came out well below estimates at 1.3% compared to 1.7% forecast and 1.7% previous, and this increased speculation the Reserve bank of Australia (RBA) would have to start cutting interest rates again. Interest rate cuts are negative for a currency.
The sustainability of the rising price of commodities has been brought into question, especially that of Iron Ore, Australia’s second largest export. The strong recovery in commodities had supported the aussie so far but it is feared this support will now be withdrawn.
The price of Iron Ore could fall dramatically after the Chinese government brought in regulations to prevent speculation on commodities at its largest futures exchanges. According to research over 50% of the rally in Iron Ore has been driven purely by speculation and not improving fundamentals or demand-supply dynamics.
The increased chance of the US dollar strengthening is likely to have a further negative impact on commodity prices, which according to an international standard are priced in dollars. This came after language warning about the risks of outside global factors on the US was erased from the last FOMC statement, removing a further obstacle to the Fed raising interest rates. Whilst the slow growth in Q1 has decreased the probability of a June hike somewhat, it remains a possibility.
For the pound, Brexit themes dominate.
Current EU Referendum polls are showing a continuing widening lead for the ‘Remain’ camp.
The large number of undecideds (15%+) would probably vote to Remain if forced to come down on one side or another. How the large undecided eventually vote is expected to swing the vote one way or another.
A report from the treasury about the consequences of a Brexit saw considerable risks to the economy. This, and President Obama’s admission that the US would not automatically come to the UK’s aid with a replacement free-trade agreement should it leave the EU may have supported the stay campaign.
According to a research note from UniCredit’s Chief Global Economist Erik Nielsen, even without consideration for vacillating voters Remain’s lead has now extended to double digits and betting shops are placing odds of staying in the EU at over 70% (Ladbrokes currently offer 73% and Betfair 75%) - from under 64% previously. They are normally accurate.
Some analysts are arguing that the April rally will not extend as there will always be some risk of Brexit up until the actual Referendum votes are counted. Therefore, sterling will always carry some weakness from that risk.
Overall we can assume then that about a half of the Brexit fear premium has been recouped in the April rally. The recovery from the 1.38 March lows to the current 1.45-46 levels represents about a 5.0% gain. According to UniCredit Brexit fears accounted for an 8% when they fell to 1.40 at the start of April. That translates into roughly 9-10% to the actual final trough lows for the pound of 1.38.
This is admittedly a fairly substantial amount, and the lessening fear of a Brexit may be running out of impetus, after all there is always a risk of the UK voting to leave right up until the last vote is cast.
Another factor in the pound’s rise, however, is increasing rate hike expectations:
“Interestingly, 12-month BOE rate hike expectations have firmed and the British Pound has traded higher even as UK economic data outcomes has deteriorated relative to consensus forecasts in recent weeks,” says Ilya Spivak, Currency Strategist at DailyFX.
According to a recent note from Capital Economics, however, the assumption that Remaining in the EU will increase the probability of the BOE increasing interest rates is false, as there is less chance not more the BOE will raise rates by the end of the year if it remains in the EU, because the sudden rapid appreciation of sterling following a Remain win will place downwards pressure on inflation, by making foreign imports cheaper.
Data hotspots in the week ahead
The main focus will be the RBA rate meeting on Tuesday May 3. The recent lower-than-expected inflation data for the first quarter shocked markets and makes this a ‘live’ meeting according to analysts at Citi, which means they see a considerable probability of the RBA cutting interest rates, probably from the current 2.0% to 1.75%. This would be negative for the Australian Dollar. Not all analysts are of the opinion there will be a rate cut, however, as Australian lender Westpac expect the bank to stay pat.
The other main release for Australia are Retail Sales on Wednesday, with a 0.3% rise expected mom in March.
For the pound the focus will be on PMI’s with Manufacturing, Construction and Services in April all released in the week ahead.