- Techs favour GBP/AUD upside

- Iron ore prices near-term headwind for AUD

- Stock market recovery could provide AUD support

- Watch RBA on Tuesday

Image © Adobe Images

GBP/AUD spot at publication: 1.7985Bank transfer rates (indicative guide): 1.7350-1.7480FX transfer specialist rates (indicative): 1.7550-1.7800More information on specialist rates, hereThe Pound-to-Australian Dollar (GBP/AUD) recorded a new two-month high at the start of February, with the pair hitting 1.80 on Monday amidst an environment of positive technical momentum and mixed fundamentals for the Aussie.

Sterling advanced by nearly a percent against its Australian counterpart in January and a positive near-term technical setup courtesy of four successive weeks of gains hints that further upside can be realised.

The gains for the Pound didn't come just against the Australian Dollar but against all G10 currencies as Sterling benefited from the view that the UK leads its G10 peers in the vaccination race and a lingering Brexit premium must be discounted following the signing of the EU-UK trade pact in December.

GBP/AUD is subject to positive short-term momentum with a number of indicators advocating for further advances: the price resides above both the 21-day and 50-day moving averages, meanwhile the Relative Strength Index (RSI) is positive at 65.67.

Based on a basic observation of short-term technicals, Sterling is therefore favoured over the coming days.

However, it can be argued the bigger picture arguably favours the Australian Dollar, which was one of the best performing currencies of 2020 thanks to the global recovery trade.

If we take a step back and consider the monthly timeframe, we are left wondering if the recent jump in GBP/AUD is a mere consolidate phase in a bigger decline:

While the longer-term chart above does appear to favour more Australian Dollar gains, it must be noted that over recent days there has been something of a shift in the fundamental dynamics that benefited the currency for much of 2020.

Australian Dollar losses accelerated on Wednesday and Thursday last week amidst a sharp drop in global equity and commodity prices, with iron ore seeing in particular seeing a sharp reversal after months of gains.

The Australian Dollar fell against Sterling, Euro, Dollar and other developed market currencies in sympathy with a decline in iron ore prices, confirming the importance of this commodity to overall AUD valuations. Iron ore is Australia's premier export and foreign exchange earner, declines in iron ore prices therefore can negatively impact on the country's foreign currency earnings potential and its currency.

"The pullback in iron ore prices is driven by a material decline in Chinese steel mill margins and expectations for lower steel demand from China. China’s Ministry of Industry and Information Technology vowed to cut crude steel output in 2021 compared to 2020," says Elias Haddad, Senior Currency Strategist at CBA.

How iron ore prices perform over the coming week could well influence whether or not the Australian Dollar returns to its dominant ways.

{wbamp-hide start}

A key risk to holding a bullish Australian Dollar stance is that China's economy starts to slow and start weighing on demand for Australian exports.

Data out on Feb. 01 was therefore not supportive for the Australian Dollar after it was revealed China’s official manufacturing purchasing managers’ index (PMI) fell to 51.3 in January from 51.9 in December. Markets had been expecting a reading of 52.7, suggesting the soft reading was unexpected.

The official non-manufacturing PMI, which measures sentiment in the service and construction sectors, fell to 52.4 from 55.7.

Above: AUD has been tracking iron ore prices of late. Image courtesy of Credit Suisse. Data: the BLOOMBERG PROFESSIONAL™ service, Macrobond, SGX Singapore Exchange

But the Australian Dollar retains a 'high beta' - i.e. is positively aligned to movements in the world's main stock markets, particularly the U.S. S&P 500. Therefore, a strong week for stock markets could in turn benefit the Aussie.

"Suffice to say that whether the short term direction of AUD is up or down is largely in the hands of risk sentiment, in which respect the negative correlation between the USD and the S&P 500 is almost as strong as the positive one is between the S&P and AUD," says Ray Attrill, Head of FX Strategy at NAB.

Stock markets fell in the previous week as institutional investors deleveraged in the face of an onslaught of buying by retail investors in heavily shorted stocks such as GameStop. The sudden price rise meant some hedge funds were nursing multi-billion dollar losses as their short positions were wiped out, leading to concerns as to their viability.

"The situation has the potential to unravel and deleverage a lot of long and short positions by hedge funds, as closing out the shorts starves hedge funds of funds they use for leveraged long trades," says John Meyer, Partner and Head of Research at SP Angel, explaining why the broader equity market suffered losses. "We expect hedge funds to close short positions in smaller, less liquid stocks and while there will be relatively few GameStop situations, there will be stocks that rise on the move."

The fundamental macroeconomic backdrop for stock markets remains unchanged and therefore a sense that the recent market declines are linked to technical positioning shifts is a popular one amongst analysts we follow.

If stocks can put in a week of gains, the Aussie could benefit.

But the Australian Dollar faces domestic considerations too.

The Reserve Bank of Australia (RBA) give their policy decision on Tuesday, where interest rates and quantitative easing settings are expected to be left unchanged, but market attention will be on the tone of the guidance concerning future policy moves.

CitiFX strategist Dan Tobon expects the RBA will: (1) upgrade economic forecasts for Australia; (2) not announce any new policy adjustments to LSAP or YCC; (3) mention recent currency strength.

"In aggregate, we see this as being tactically negative for AUD, though would add on dips after the meeting as the structural AUD bullish case remains intact," says Kurran Tailor, analyst at Citi.

The RBA event is likely to trigger short-term moves say most currency analysts we follow, instead how equity markets and commodity markets perform will be of primary concern for the Aussie.