- AUD lags commodity rally

- GBP/AUD hits new multi-month highs

- "Cause for concern on the bullish AUD story"

- But too soon to bet on a decline says HSBC

Image © Adobe Stock

GBP/AUD reference rates at publication:Spot: 1.8216Bank transfer rates (indicative guide): 1.7577-1.7700Money transfer specialist rates (indicative): 1.8050-1.8080More information on securing specialist rates, hereSet up an exchange rate alert, hereThe Australian Dollar could be a great deal stronger were it as responsive to the massive rally in global commodity prices as it has been in the past, after all this is the 'poster-boy' of the "commodity currency" complex.

Despite the march higher in commodity prices - with iron ore prices reaching a record already in May - the Australian Dollar has languished against a number of its peers.

For instance, the Pound-to-Australian Dollar exchange rate (GBP/AUD) is actually higher now than it was at the start of May and on May 19 reached a new multi-month high at 1.8287.

Other key Aussie Dollar pairs - such as AUD/USD and EUR/AUD - reflect similar dynamics.

Brent Donnelly, Senior FX Dealer with HSBC in New York, is a veteran of the currency markets and he has taken a keen interest in the Australian Dollar's apparent failure to ignite of late.

"The conversation around AUD here on the desk has mostly revolved around how poorly it trades in what is pretty much a commodity supercycle. The chart below shows AUDUSD vs. Australian Terms of Trade since 2000. As you can see, the terms of trade is back to 2007 or 2011 levels while the currency continues to languish," says Donnelly.

Image courtesy of HSBC.

Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.

"These types of divergences can be viewed as bullish (it needs to catch up!) or bearish (it doesn’t trade well!). To me, it’s bullish AUD as long as the terms of trade and bull reflation story continues because there is a lot of room for it to appreciate, but when the underlying story turns, it can often be mega bearish," says Donnelly.

"Can’t go up, must go down comes into play at some point and it’s possible that point is now," he adds.

Australia is a major exporter of iron ore and the solid demand from China seen since 2020 has underpinned the country's terms of trade.

In fact, Australia's Terms of Trade is near all-time highs touched in 2007 and 2011, yet the currency can’t even get above its 2018 high opines Donnelly.

{wbamp-hide start}

In the past the Australian Dollar has risen alongside the improved trade picture, but at the same time the yield paid on Australian bonds also rose, creating a strong inflow of foreign capital into Australian monetary assets.

"In other words, it’s not terms of trade that drives AUD but the impact terms of trade has on rates. In the past, ToT swings have led to interest rate swings. This time, not so much," says Donnelly.

The Asian link to the Australian economy and its currency cannot be underestimated and could help explain why the currency is apparently failing to meet upside expectations.

"There is cause for concern on the bullish AUD story," says Donnelly. "The reflation story has turned to stagflation concerns, and COVID is ticking up in some parts of Asia. Taiwan stocks, KRW and other assets in the region are selling off."

From a strategic perspective the HSBC trader says he won't chase AUD downside until copper and iron ore roll over.

"Lumber, iron ore and copper have stopped going wild to the topside but the reversals are not yet large enough to trigger a sell AUD signal," says Donnelly. "I am on high alert for any turn in copper as that will be the final piece of a bearish AUD puzzle."