The Australian Dollar should remain supported even if China tightened financial conditions further.

“Tightening financial conditions” means limiting the availability of credit.

“Our framework shows that even in the event of further tightening, AUD/USD is probably reasonably priced,” argue UBS.

China has long been a key variable in the Australian Dollar story as they are Australia's largest market for the export of raw materials.

When Chinese demand is strong, so too is the Aussie Dollar. However, concerns over the trajectory of Chinese economic growth have been raised of late with those watching foreign exchange markets questioning what it might mean for the currency going forward.

The Chinese Authorities have been making it harder for companies and individuals to borrow money due to fears that rampant lending in previous years may have built up a bubble of debt which could now be a financial stability risk.

“Authorities in Beijing are determined to reduce the leverage in the financial system in an orderly manner — and have large incentives to do so. Yet that does not mean the process will be free of corporate victims,” said a recent report in the FT.

UBS’s analysis shows the Australian Dollar holding its value despite risks that demand from China could tail off.

One reason for the Aussie’s resilience is that UBS sees the currency as already undervalued, and therefore a priori more likely to rise.

“AUD has weakened as iron ore prices have fallen sharply, but our medium-term fair value model continues to show undervaluation,” said UBS’s Daniel Waldman.

China is not the only market for Australian goods and the backdrop of wider global growth is expected to support the Australian Dollar according to UBS.

The Australian economy is reasonably strong, but the Reserve Bank of Australia’s (RBA) current caution could be part of the explanation for the Aussie’s undervaluation.

“Despite growth seen accelerating to 3% and unemployment below 6%, the market continues to price a higher likelihood of a cut than a hike this year in Australia. This should provide some further support for the AUD, as our economists expect an unchanged RBA this year and forecast a gradual rise in core inflation to 2.1% by Q1-18,” said Waldman.

AUD/USD Upside Potential

“AUD/USD is neutral to positive. The market last week eased back in the middle of the channel and is recovering from there. Very near term we are seeing a rebound from the 200-day MA at 0.7530. Above 0.7635/52 will target the top of the triangle at 0.7712.”

We see the break above the 0.7638 highs as key in establishing an uptrend for the pair, and such a move would probably lead to a move up to resistance highs from the upper border of the large triangle pattern at 0.7700.