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- AUD is 2018's worst major currency performer

- China-US trade relations could thaw, aiding AUD recovery

- Extreme bearish positioning could be a contrarian signal

- But Australian housing market poses headwinds

The Australian Dollar has lost over 8.6% of its value against the US Dollar and 6% of its value against the Pound in 2018, but we are told the chances of the currency having found a bottom have increased.

Max Loh at SeekingAlpha has identified to arguments for, and one against, the prospect of an Australian Dollar recovery over coming weeks.

One factor suggesting the Aussie could be in for a recovery is the state of the futures market which is currently showing an extremely high balance of bearish bets against the Aussie.

Currencies tend to react in a contrarian fashion to extreme positioning data: rising when speculators are excessively bearish and falling when they are heavily bullish.

"As Warren Buffet used to say: "Be fearful when others are greedy, and be greedy when others are fearful". I suggest entering a tactical bullish position to buy Invesco CurrencyShares Australian Dollar Trust ETF (FXA) when the AUD is sitting 12% below its 52-week highs," says the analyst.

An easing in acrimonious trade relations between the US and China could be one fundamental driver for a recovery in the Aussie.

The trade war between the US and China has been one of the major catalysts for the slide in the Australian unit, which, because of its high dependency on exports to China has is seen as a proxy gauge for Chinese economic wellbeing.

Donald Trump's main reason for mounting the trade war was a desire to rebalance the deep trade deficit between the West and China and bring about a rebirth in US manufacturing via the 'made in America' ethos.

However, the reality has been more complicated and many economists are saying the fallout from the trade war has also impacted negatively on US companies and sectors, especially those in Trump strongholds - such as soybean farmers, for example, who used to export largely to China but have been hit with punitive tariffs from Beijing.

The fact the Chinese have tactically targeted Trump voting centres for their tit-for-tat tariffs is further reason to see a political motive in the US president trying to diffuse the conflict with his opposite number.

Now the close proximity of mid-term elections means there could be an incentive for Donald Trump to do a deal with President Xi Jinping lessening the pain on some of his voters.

"Catalysts that could send the AUD higher would be a fruitful meeting between Trump and Xi Jinping in November, where presumably trade talks will be on the agenda. Trump knows he has a mid-term election to contend with in November as well, and a protracted trade war will likely cause his would-be voters many nervous and sleepless nights," says Loh.

Loh thinks the AUD could recover in November when Trump and Xi are scheduled to meet for talks. Both have incentives to improve relations and reach an entente over trade.

"A consensus on trade agreed with fellow strong-man Xi will remind Trump's voters that he has their best interests at heart, while Xi will be happy to reduce damage to the domestic economy / stock market," says Loh.

In this particular 'game' it may be that a stalemate between the two players could be the best outcome - at least for the Aussie.

"If this chess match between both superpowers ends in a stalemate without a victor, the winner would likely be risk-on trades, which include the AUD," concludes Loh.

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But Australian Dollar Faces Significant Domestic Headwinds

The Reserve Bank of Australia (RBA) is not expected to raise interest rates anytime soon and higher rates are normally a major driver of currency appreciation.

Higher interest rates increase the attractiveness of a country as a place for foreign investors to deposit their capital and this increases inflows and demand for the domestic unit of exchange.

Yet one of the things which have been holding down the Aussie is the view that the RBA is unlikely to lift interest rates anytime soon.

The extremely high overall level of debt amongst the populace, which stands at an average of circa 190% as a ratio to average income, is the main reason for not expecting them to increase rates.

It makes the economy vulnerable to a 'credit crunch', and the wrong move in such a situation would for the RBA to raise base lending rates, which would push up the cost of repayments even higher.

"Australia's domestic picture does not look pretty, and I want to highlight two specific statistics: First, household-debt-to-disposable-income ratio sits close to 190%, an astonishing and perilous statistic. This means Australia's economy is extremely vulnerable to a hard landing, as a slowdown in income growth would likely lead to a trickle-down effect of increased loan defaults," says Loh.

Another concern which makes it unlikely that the central bank will increase rates is what it calls the "frothy housing market".

This refers to house prices, which have risen strongly in an era of cheap borrowing (caused by low-interest rates) but have moderated more recently.

The RBA does not want a situation in which house prices suddenly fall causing defaults and a housing crisis, as might occur if they increased interest rates, which could make mortgage repayments increasingly unaffordable.

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