Second leg of Risk Assets Correction Creates Upside Risk in EURAUD

<p><strong>Key points:</strong></p>
<ul>
<li><strong>EURAUD soared up by almost 3,000 points in March touching 1.98 level mirroring the flight from risk assets (stocks, commodities, HY bonds);</strong></li>
<li><strong>Sustained recovery of commodity prices limits downside risk for AUD;</strong></li>
<li><strong>Another “leg” of stock market correction increases chances for a test of the upper bound of the medium-term trend channel (see technical picture below).</strong></li>
</ul>
<p>The recent EURAUD move by almost 3,000 pips in a very short time puts it in the list of the most volatile FX crosses. Until the explosive upside move in March, the pair traded in the narrow range of 650 points, also skewed slightly to the upside.</p>
<p>The move coincided with sell-off in equity markets and HY fixed income markets. Commodity prices, which determine significant portion of Australian export cashflows and domestic economic activity, also tanked. The risks in assets denominated in AUD increased due to increased uncertainty in their cash flows, which led to capital flight of investors who used low interest rates to profit from carry trades, including European investors.</p>
<p>Commodity prices have recovered supported by expectations and some progress towards easing of lockdowns and economy re-openings. Commodity risk for AUD declined, which was also reflected in rapid pullback in EURAUD pushing the pair back into medium-term channel. However, the risk of downside reversal in stock markets, although faded into the background, remains high. At least because the rally ignoring fundamentals, seems irrational. The argument that deterioration of economic data was reflected in the March correction seems unconvincing, because if so, then solid growth expectations should be reflected in the current recovery. But are there any? Firstly, recession usually shortens the forecast horizon because of increased scope of uncertainty (range of outcomes). Secondly, companies will long reach the pre-crisis level of sales, which at least follows from a record rise in unemployment, which usually decreases more slowly than it grows. Hence, we can’t expect a quick recovery in consumer spending.</p>
<p>There is an assumption that suppression of yields by central banks has led to the fact that there may simply be nowhere to flight stocks (cash has negative real yield because of inflation), but then this is speculative growth and it cannot be sustainable.</p>
<p>Below is a technical view on EURAUD:</p>
<p><img class="alignnone size-large wp-image-43007" src="http://blog.tickmill.com/wp-content/uploads/2020/05/1-4-1024×694.png" alt="" width="1024" height="694" srcset="https://blog.tickmill.com/wp-content/uploads/2020/05/1-4-1024×694.png 1024w, https://blog.tickmill.com/wp-content/uploads/2020/05/1-4-300×203.png 300w, https://blog.tickmill.com/wp-content/uploads/2020/05/1-4-768×521.png 768w, https://blog.tickmill.com/wp-content/uploads/2020/05/1-4-1536×1041.png 1536w, https://blog.tickmill.com/wp-content/uploads/2020/05/1-4-2048×1388.png 2048w" sizes="(max-width: 1024px) 100vw, 1024px" /></p>
<p>AUD recouped losses after an intense March sell-off relative to EUR, returning to the medium-term daily channel moving in the narrow downward trend channel. In early May, EURAUD broke the short-term downtrend, which may indicate that main wave of sell-off has ended. The new goal is a test of the upper bound of the medium-term channel in the region of 1.7350-1.7400.</p>
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