- AUD catches a breather as USD rally takes a pause.

- Looming RBA statement and wages data will be key to outlook.

- Analayst opinion is divided but risk-reward favours the AUD bulls.

© Filipe Frazao, Adobe Stock

The Australian Dollar edged higher Thursday following several days of punishing losses although, judging by the cacophony of analyst opinions on the subject, the Antipodean currency's trajectory from here is as uncertain as ever.

This week saw the Australian Dollar break below a key level of support against a resurgent US Dollar, exposing it to the prospect of sharp steep losses, while conflicting signals of rising commodity prices and poor economic data from China leave the path ahead obscured from view.

The downmove comes as American 10 year bond yields sit comfortably above the 3% threshold, after having crossed the Rubicon on Monday, marking the highest level since 2011 and has proven a powerful stimulant for the US Dollar.

Above: 10 Year US Government Bond Yield.

The market's sudden focus on the issue of US bond yield signals a shift in regime on currency markets where the one rule is that what influences a currency today might be replaced by another influencer the next day.

We are yet to see how long the current regime lasts for - is it temporary or will it become more protracted?

Whatever the case, the Aussie does not appear to enjoy this environment owing to the prospect of interest rates in Australia remaining unchanged for sometime.

Markets remain convinced the Reserve Bank of Australia will stay sat on its hands for at least the foreseeable future, which has seen the increase in Australian yields lag that of their US counterparts.

Above: 10 Year Australian Government Bond Yield.

Yield support for the Aussie unit had been declining for some time but this has tipped the balance of relative interest rates even further against the Antipodean unit.

It now pays investors handsomly to park money in the American bond market rather than the Aussie market, which requires one to dump the Aussie currency and buy US Dollars.

"The two-year, five-year and 10-year yield gaps are now at such extremes that US yields actually stand above their Australian equivalents, a situation not seen since May 2000 when the AUD was trading around USD 0.5500," says Simon Derrick, chief currency strategist at BNY Mellon.

Above: AUD/USD rate shown at weekly intervals. Captures break of major trend line.

Previously, the opposite was true as investors could earn more by parking their cash in Australia, but a steady increase in US interest rates combined with the Reserve Bank of Australia's ambivalence about being left behind have put paid to this equation. The correlation between Australia's currency and this so called "yield spread" has been rising steadily in recent months.

Not only that but prices of iron ore, Australia's largest export, saw a terrible start to the year which has served to compound pressure on the country's currency. Although they have recently stabilised. BNY's Derrick flags this, and recent developments in China, as significant for the Aussie Dollar.

"Between the start of 2016 and the end of 2017 the AUD was able to shrug off a sharp decline in yield support against the USD across much of the curve, thanks to improving sentiment surrounding Australia’s major trade partners," the strategist writes. "However, the AUD has come under increasing pressure since the start of the year as both iron ore and Chinese equity prices have weakened."

Above: Iron Ore price with Shanghai Composite Index (Purple Line) Overlay.

Derrick flags a more downbeat mood coming from China last week which, presumably, is the result of disappointing economic numbers. After all, last week saw data show first-quarter growth in Chinese industrial production and fixed asset was much slower than the market had expected, prompting questions of whether a renewed slowdown could be on the cards for the world's second largest economy.

This slowdown would be bad for Australia if it were to materialise and could encourage speculators to bet against the currency. Derrick notes Chicago Futures Trading Commission data showing speculators beginning to build short positions in the Australian Dollar, although this bearish bet is currently only a fifth of the size it reached back in late 2015.

"The AUD (much like GBP) has shown a marked propensity over the past 18 years for rapid and sustained 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," Derrick warns.

Above: BNY Mellon graph showing annual Australian Dollar price changes in % terms.

What matters now for the Aussie is whether the ongoing surge in US bond yields abates itself and if investors can be encouraged to bet on a change in the RBA's monetary policy stance at any time in the near future. Only time will tell whether the US yield story dies away on its own while next week's RBA policy statement and the first quarter wage price index, due on May 15, will provide an answer to the latter.

"The RBA seems to be the central bank for which investors are most clearly underestimating the likelihood of a progressive reduction of the current very accommodative monetary policy stance," says Roberto Mialich, an FX strategist at UniCredit Bank. "This means that the Aussie Dollar is currently the most exposed among the three commodity currencies to some positive “repricing risk” should global trade tensions ease further and investors’ focus turn back to fundamentals."

Mialich says that monetary policy expectations in Australia are too benign and this is where the seeds of an Aussie Dollar recovery can be sown. He is not alone in having high hopes for the Antipodea unit either because other strategists have also kept an eager eye on the currency during recent weeks.

"We remain of the view that AUDUSD pullback could be the last chance for us to buy the antipode as AUD typically rises in a growth environment with modest inflation," says Saktiandi Supaat, an FX strategist at Maybank in Singapore, in a note Thursday. "We stick to our view that we dips are seen as opportunities to accumulate."

The AUD/USD rate was quoted 0.13% higher at 0.7578 during the morning session Thursday while the Pound-to-Australian-Dollar rate was unchanged at 1.8414.

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