ANZ - FX - Jumping on board

Chart 1: IMM positioning week ending 26 May
The USD continues to be dumped with the index hitting a five-month low on Friday night. Weaker than expected US data added to the sell tone. The Chicago PMI unexpectedly dropped from 40.1 to 34.9 with the employment index falling - a bad sign ahead of Friday's non-farm payrolls release. Q1 US GDP was also revised up by less than expected, from -6.1% to -5.7%.

The weaker USD has seen EUR/USD move back above 1.41. While EUR/USD has just failed to break the key fibo level of 1.4185, the uptrend in this cross is gathering momentum on the charts with the 50-day moving average (1.3442) now comfortably above the 200-day moving average (1.3370). The ECB policy meeting on Thursday night is the major risk event for this cross this week. A stronger EUR must be killing European exporters, but we're not sure this will be enough for the ECB to move to QE this week.

After lagging the EUR for most of the last week, the AUD has now joined commodity markets and is outperforming, along with the other high-yielding currencies CAD and NZD. AUD/USD is sitting above USD0.80 this morning after surging to an 8-month high of 0.8074 on Friday night and is also stronger against most major crosses. The ease with which AUD/USD pushed through the key fibo level of 0.7930 on Friday night is a powerful signal for the uptrend in the AUD and suggests next resistance of 0.8383 could now easily be in reach.

Chart 2: IMM positioning vs AUD/USD
The rise in AUD (and the other high-yielders) is occuring as risk appetite for a global economic recovery continues to build, despite the fact that the US economy remains in a world of hurt. This is the most troubling part of this AUD rally at the moment, as we're sceptical that the rest of the world can rebound without the help of a recovering US consumer. These are themes to play out over the second half of this year.

In the short-term, the markets are sending a strong signal for the reflation trade. This is clearly evident in the latest IMM positioning data for the week ending 26 May. Net AUD longs have risen sharply to around 32k contracts. This is the highest level since July 2008 but is still well below the 2007 peak of around 80k contracts (see chart 1). These sharp moves generally suggest the risk is for a sharp reversal. Nevertheless, with AUD easily breaking through the key tech levels on Friday night, we expect the IMM market will continue to chase this rally, providing further support for the AUD above 0.78 in the short-term(see chart 2). Our own customer base is also now becoming convinced of this AUD rally and has become notably net long for the first time since mid-April (Chart 3).

If you needed any further evidence of the reflation trade it was that IMM longs for NZD are building faster than even AUD longs (see chart 1), indicating downward pressure on the AUD/NZD cross this week.

Chart 3: ANZ FX positioning index
This week's local data flow is also likely to provide some support for the AUD this week, especially with the RBA universally expected to stay on hold tomorrow. Even if the data flow comes in worse than expected, it is likely to show how well Australia is performing relative to the rest of the world. Of most interest this morning will be April retail sales at 11:30. After a strong 2.2% rise in April (as the government stimulus payments commenced), retail sales is expected to hold this strong level and rise by another solid 0.5%. There is an unusually wide range around the forecasts (from -0.8% to +2.5%), mainly reflecting reduced confidence in the stability of the series after last month's incredibly strong rise in department store sales (of 13.2%). So if sales surprise on the downside, it will most likely be interpreted as data volatility, as opposed to fundamental weakness, and as such shouldn't weigh on AUD too much. The bigger risk for AUD in this environment is if retail sales come in at the topside of expectations (of +1.0% or more).

At 12pm local time we will also receive Chinese PMI manufacturing data for May (last reading was 53.5).

The other local data out today is company profits and inventories. While these are important for Q1 GDP (out on Wednesday), they shouldn't provide too much impact to the AUD this morning, unless of course they surprise to the upside. Current market forecasts are for company profits to fall 4.5% (we are weaker at -7.5%). Inventories are expected to fall 1.4% (we are weaker at -2.0%).