- AUD at risk of steep losses warn BNY Mellon currency team.

- Much depends on Trump and China's will to defend the Renmimbi.

- If the PBOC allows the Renmimbi to crumble, AUD will follow suit.

© Greg Brave, Adobe Stock

The Australian Dollar fell in jittery markets Tuesday and could on course for steep declines over coming months, according to strategists at BNY Mellon, who are warning that President Donald Trump's anticipated tariffs on more than $200 billion of Chinese exports to the US will be a watershed moment for the Antipodean currency.

Australia's Dollar is not alone in approaching such a pivotal point as the new tariffs planned by the White House have been labelled a landmark event for everybody, one which could see the so-called "trade war" between the US and China descend into an all-out economic or financial conflict that has consequences for markets the world over.

However, given China is Australia's largest trading partner and the Antipodean currency is underwritten by exports of commodity goods, prices of which are all highly sensitive to sentiment toward China and the global economy, the Australian Dollar could be among the first and most bruised casualties.

"With plenty of discussion taking place about what a new round of US tariffs against China might look like, the key question therefore when considering the AUD is how Chinese markets along with the CNY might react," says Simon Derrick, chief currency strategist at BNY Mellon, in a note Tuesday.

President Trump has announced the intention to impose tariffs on Chinese exports worth a total of $250 bn, although the levies on $200 bn of this number are yet to actually be introduced. Trump said at the weekend he is ready to move forward with the tariffs but that whether he does or not will depend on actions from the Chinese side.

The US alleges China uses "unfair" trading practices that, among other things, force American companies operating in the country to hand their intellectual property over to Chinese companies. Combating these practices was a key part of President Trump's electoral campaign offering and is among a range of issues that he has long spoken out against.

"The $200 billion we’re talking about could take place very soon, depending on what happens with them. To a certain extent, it’s going to be up to China. But we’ve taxed them $50 billion — that’s on technology. Now, we’ve added another $200 billion. And I hate to say this, but, behind that, there’s another $267 billion ready to go on short notice, if I want. That totally changes the equation," Trump told reporters aboard Air Force One at the weekend.

It is unclear exactly when the White House intends to make a final decision on the tariffs although most analysts say it will likely come inside of September and almost certainly will come before the US midterm elections in November. The idea here is that Trump may want to sound tough on international trade issues ahead of the vote, given the siginificant role international trade and the offshoring of American jobs played in his 2016 presidential campaign.

From an Aussie Dollar perspective, the Chinese response on the currency markets will be important.

Derrick and the BNY team say that if Chinese officials do not place a firm floor beneath the Renmimbi and defend it the next time that tariff salvos come flying from the White House, just like they did when the currency came under pressure in January 2016, then the Australian Dollar could be in trouble.

"Should China decide to avoid repeating the experience of January 2016 in the face of an intensification in trade war tensions then the risk is that the AUD could also come under threat," says BNY's Derrick.

This is because with the Renmimbi subject to state control via the People's Bank of China, the Australian Dollar is seen by traders as a better mechanisms for expressing unease over the trade conflict between the US and China. As a result, movements in the Renmimbi are often mimicked and are occasionally magnified in Australian Dollar exchange rates.

However, this time China has an incentive to sit back and let the Renmimbi take the strain because a weaker currency will make Chinese goods cheaper for Americans to buy. In other words, a currency devaluation would counter the effect of President Trump's tariffs.

"Were this to happen then it would come at an interesting time. Not only is the AUD sitting just above its January 2016 lows but it’s also noticeable that yield support for the currency has continued to deteriorate over the summer to, in many cases, the weakest levels in 20 years," Derrick warns.

Australia's currency has already been badly bruised this year because 2018 changes in the global interest rate landscape have created an incentive for traders to sell the Antipodean in favour of buying the US greenback, Canadian Dollar and other currencies.

This was after it became clear Reserve Bank of Australia will likely keep the Aussie interest rate at its current record low of 1.5% for a while yet, while the Federal Reserve and others have continued to raise their own rates.

The Aussie has long enjoyed support from interest rates that were typically higher than those elsewhere in the developed world, although it no longer has any interest rate advantage over the US and Canadian Dollars, while the UK-Australia yield gap is also narrowing now the Bank of England has raised interest rates twice in the last year.

Looking ahead, the danger is that with the trade threat running high and yield support no longer able to compensate for the risk of holding the currency, the Australian Dollar could be facing further sharp declines.

"The AUD (much like GBP) has shown a marked propensity over the past 18 years for rapid and substantial moves. As one measure of this, it’s worth noting that over ten 20% y/y moves have developed for the AUD against the USD since the start of the new century. All this suggests that this could prove a critical few weeks for the AUD," Derrick warns.

The AUD/USD rate was quoted 0.24% lower at 0.7090 Tuesday and has fallen 9.18% in 2018 while the Pound-to-Australian-Dollar rate was 0.02% higher at 1.8328 and has risen 6.29% this year.

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GBP/AUD Pointed Higher

The pair has witnessed three up-weeks in a row since the 1.7410 lows resulting in the formation of a three white soldiers bullish Japanese candlestick pattern, which is a strong indication of a reversal in the trend.

The pair is now forecast to continue rising to the next major resistance zone which lies at the level of the 200-day moving average (MA) at 1.8346, with our target just under at 1.8340.

Large moving averages tend to act as tough obstacles to trending prices which often stall, pull-back or even reverse after meeting them.

Confirmation of further upside to the target would come from a break above the 1.8224 highs.

The daily chart shows how the pair has now broken clearly above the 50 and 200-day moving averages and has formed a bullish sequence of higher highs and higher lows which establishes the short-term trend as up.

Although momentum has almost reached overbought extremes it is not yet quite over 70, nevertheless, it is a sign traders should operate with caution if considering opening any new long trades.

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