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- AUD weakens on renewed tensions between U.S. and China over Huawei.

- Huawei spat undermines hopes for U.S.-China negotiated trade solution.

- But TD Securities says Asian corporate clients see AUDUSD back at 0.75.

The Australian Dollar weakened Tuesday after an escalating international dispute over the detention of Huawei's finance director in Canada was seen threatening an eagerly anticipated deal to end the so-called trade war between the U.S. and China.

The Globe and Mail reported Tuesday the U.S. is going ahead with a request to extradite Meng Wanzhou, finance director of telecoms giant Huawei, over allegations of "banking fraud" that relate to U.S. sanctions against Iran.

David MacNaughton, Canada's ambassador to the U.S., is the on-the-record source of the claim, which drew instant condemnation from Beijing as well as threats of retaliation against both the U.S. and Canada.

"China will take action in response to measures taken by the US,” Hua Chunying, a spokesperson of China's foreign ministry, told the South China Morning Post. “Everyone has to be held responsible for their own actions. Both the US and Canada should be aware of the seriousness of the case and take steps to rectify the mistake.”

China has already detained two Canadian citizens on questionable grounds since Wanzhou was arrested and a court has imposed the death penalty on a convicted Canadian drug smuggler who had previously been sentenced to 15 years in prison for his crime.

Wanzhou was arrested in Vancourver in December. The U.S. claims she was responsible for breaching American sanctions against doing business with Iran, although China has decribed the charges as a politically motivated fabrication.

Both China and the U.S. have been in negotiations since early December that are aimed at ending the trade war between the two. President Donald Trump has imposed heavy tariffs on China's exports to the U.S., citing "unfair trade practices" that must be addressed before the levies will be lifted.

"The extradition request is seen by some market participants as a proxy for US‑China trade frictions," says Joseph Capurso, a currency strategist at Commonwealth Bank of Australia. "The 90 day trade ‘cease fire’ ends in early March. There is plenty of time for an arrangement on trade to be agreed between the US and Chinese governments. A Chinese government delegation will visit the US next week (30‑31 January)."

Negotiators have until March 01 to reach a deal that satisfies the White House or the 10% tariff covering $200 billion of China's annual exports to the U.S. will automatically increase to 25%. The U.S. may then also impose tariffs on the remaining $267 billion of goods China exports to the America each year.

All of the trade talk is important for the Australian Dollar because the Antipodean currency is underwritten by a mammoth bilateral commodity trade with China, which means it is sensitive to developments effecting China's economy and currency, the Renmimbi.

Official data showed Chinese GDP growth slowing by 10 basis points to an annualised pace of 6.4% in the final quarter of last year. GDP growth for 2018 overall was 6.6%, down from 6.8% in 2017, although many western economists claim the economy actually performed much worse than that.

Above: AUD/USD rate shown at daily intervals.

The AUD/USD rate was quoted -0.40% lower at 0.7130 Tuesday, and is now up just 1.1% for 2019 after having retreated steadily from a 2% gain since Friday.

The Pound-to-Australian-Dollar rate was quoted 0.59% higher at 1.8112 and has now risen by 0.08% for 2019, after reversing a year-to-date loss this week.

Above: Pound-to-Australian-Dollar rate shown at daily intervals.

"Markets are back in headline mode with a focus on US/China trade talks at the same time," says Mark McCormick, head of North American FX strategy at TD Securities. "The biggest losers are the high-beta EM currencies alongside a pullback in AUD."

Despite the unfavourable trade and growth headlines this week, McCormick says many of TD's corporate clients in Asia are looking for a deal to eventually be done and the Chinese economy to stabilise in the second quarter of 2019.

With this in mind, many of those clients have either already bought the Australian Dollar or are going to be buying it during the months ahead, in anticipation of a move up tothe 0.75 threshold by the AUD/USD rate.

"There was also not a lot of pushback on the prospects of a positioning induced rally towards 1.10 in AUDNZD in the very short-run," MCormick writes, in a note Tuesday while recalling views encountered on a recent trip to Asia.

A possible first-quarter deal to end the U.S.-China trade war would certainly be positive for the Australian Dollar, although some analysts say that optimism about the talks will not be enough to keep the Antipodean currency afloat during the coming weeks given other factors effecting the domestic economy.

"Global factors have already triggered a considerable rally but the coming weeks may provide greater headwinds from the domestic front," says Tom Nash, a currency strategist at HSBC in Australia. "A soft inflation reading for Q4 would keep it entrenched below target. If the RBA meeting offers any suggestion that the central bank is less confident the next move in rates is more likely to be up, the AUD would likely crack lower...Sell AUD-USD at 0.7180".

Poor inflation figures could easily encourage the market to speculate more heavily that the RBA will eventually be forced to cut its interest rate in 2019 in order to encourage a pick-up in inflation.

Changes in interest rates are normally only made in response to movements in inflation but impact currencies through the push and pull influence they have on capital flows and their allure for short term speculators.

"AUD/USD will remain weak and trade in a lower 0.65-0.70 range in 2019 on a further deterioration in Australia’s negative interest rate differential against the US. We see two increases in the Fed Funds Rate totalling 50 bps to 3% or double the level of its Australian counterpart," warns Philip Wee, a currency strategist at DBS Bank in Singapore.

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