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AUD/USD short-term outlook based on recent economic reports

August 29, 2016 by Shaun Overton Leave a Comment

Before commodity markets started cooling off last year, the multi-decade commodity boom drove the Australian Dollar to all-time highs against the US Dollar severally. This caught the attention of the traders who were in many cases attracted by the interest rate differentials in the AUD/USD pairing. The duo benefit of this was that traders could take a long position on the AUD/USD and earn rollover from it; while at the same time gaining from the aggressive bull-run experienced then between the pairs.

The Australian Dollar (Aussie) has however in the recent past been subjected to negative economic outlook back at home due to the bear markets in the commodities markets especially the metals. The slow-down in the Chinese economy as they restructure their economic model to boost their local consumption also had negative impacts on Australia’s commodity exports; resulting to more pressure on the Aussie. This is a reversal of the past when the currency had been identified as one of the favored vehicles for traders.

The AUD/USD currency pair has been trading within the range of 0.7600 and 0.770 in the past weeks. The currency pair has appreciated by about 5.34% for the year-to-date. Recent developments in Australia and United States of America economic environments however have been shaping the AUD/USD price actions and affecting sentiments from the traders. Among the top economic news from Australia that will shape how the price of the pair will be fluctuating into the future include the decision by the Reserve Bank of Australia to cut the interest rates to 1.5% on August 2nd 2016. On the other hand, the US released better than expected payroll’s data for the month of July 2016 and that has had a positive impact on the dollar. Both these two major announcements will be shaping the trend of the pair in the markets in different ways and ultimately they will affect your trading decision on the pair.

In a bid to boost consumer confidence and stimulate a consumption driven economic growth, the Reserve Bank of Australia cut its interest rate to 1.5% in August 2nd 2016 after another cut in May 2016 to 1.75%. The goal of the bank is to increase money supply in the economy and boost the purchasing power of consumers in order to trigger an increase in production and hence ultimately end up with higher GDP growth. It is however feared that the move will result in inflation rising hence rendering the monetary policy intervention counter-productive. With the rising inflation the Australian Dollar would eventually find itself hurt through depreciation against other major world currencies including the US Dollar. To dispel the inflation fears, Mr. Alan Oster the chief economist at the Reserve Bank of Australia said that “the outlook for inflation remains very subdued with underlying inflation expected to remain below the bottom of the 2 to 3 per cent target band until mid-2018.”

On the US economy, the labor department released the July jobs report on August 5th which was a record higher than the projections from economic analysts. The report showed that the US created 255,000 new jobs in the month of July 2016 against a forecast of about 180,000 jobs by most analysts. This data caught the market as a surprise and triggered an upward rally at the equities markets across the US. Having the payrolls expanding is therefore a proof of the confidence that both the US public and private sectors have in their economy and this re-affirms the position of the United States of America as the strongest economy in the world. The dollar is now rallying on such positive news and hence gaining more ground against other major global currencies as explained by AOMarkets in their analysis, “A resurgent USD is dominating financial news headlines and US indices are enjoying the spillover effects.”

Taken together, the AUD/USD currency pair seem to be leaning favorably on one side based on the just released economic data from both the US and Australia. The USD is riding on positive jobs data and the implied strengthening of the US economy. On the other hand the AUD is faced with potential depreciation if increased borrowing due to the rate cut results in an increase in spending that might trigger inflationary pressures. In the short-run we can therefore expect the USD to rally against the AUD before the election fever peaks in the US.

Major Portfolio Update

November 1, 2015 by Shaun Overton 6 Comments

We ended the month in the black with a 0.74% return. I realize that nobody is jumping up and down with that kind of performance, but I’m honestly very excited to see the change.

At the beginning of October, I made a substantial change to the portfolio. Previously I attempted to pick pairs that were doing well. This approach was something of a mixed bag. While some periods of performance were quite nice, such as June of this year, the month of August was pretty harsh on the portfolio. I also didn’t like that the pair selection process was still very subjective.

The QB Pro strategy, like any strategy, makes its most important trading decisions when it selects its portfolio. The strategy is not one that can make money in any given environment. Instead, it requires careful selection of instruments in order to give itself the best possible opportunity to earn a profit.

The equity curve for the month of October 2015.

Based on about 100 hours of research with Jingwei back in September, I’ve been able to reduce the amount of discretion when selecting portfolio instruments. For example, the mega-monster performance from August 2014-March 2015 was driven exclusively by the strength of the US dollar.

As anyone who buys gasoline for their car knows, the trend shifted this year out of currencies and into commodities. Specifically, commodities have taken a real beating. China’s economy is sputtering, the US like it’s unable to raise interest rates and most industries suffer from serious gluts. Oil production in the US is widely rumored to possess a severe over-capacity, as evidenced by all the junk-debt ratings on US drillers. Gold mining stocks around the world have been the red-headed stepchild of financial markets, trading at PE ratios as low as 1.0.

That weakness spread to commodity currencies, even major currencies like AUD, CAD and NZD. As I ran backtests using a portfolios of those currencies and their crosses, I noticed that the equity curve more less marched straight up through the summer. More importantly, that basket of pairs benefited from the Chinese devaluation, whereas my custom basket took a step drawdown.

I’m expecting more problems of out both China and the US through the rest of the year. Although China managed to settle down after the summer, the problems plaguing it are anything but fixed. Recent bankruptcies and bailout of state owned firms point to more cockroaches. And, you know the rule about cockroaches. Where there’s one, there’s 10 more. I expect more Chinese devaluation to follow.

Lifetime equity curve of QB Pro’s high-risk version.

The commodity currency exposure is an indirect, systematic play on this expectation. The portfolio has done well in the current environment and, given that I don’t expect any improvement at all in China, should continue to do well.

The other variable is the Fed. I had the rather unfortunate luck of launching the portfolio just in time for a Fed governor to cast doubt on any US interest rate hikes this year. The change got off on the wrong foot. But QB Pro didn’t just stem the losses. It bounced off the equity low and marched upward in nearly a straight line for the rest of the month.

The Fed meeting in October forced the governors to pretend as though a 2015 rate hike is on the table. There’s always the chance that the Fed might hike rates just to prove a point. They’ve been talking about this for 9 months now. The futures market at one point put the odds somewhere near 67% for a 2015 rate hike. Prior to the meeting, those expectations fell under 25%, then jumped back to around 50%.

Even if the Fed did raise rates, I see an impossibly low probability of a sustained program of rate hikes. The data looks like a car sputtering on fumes. There’s deflation everywhere expect for the financial markets and beef, where “investors” have been encouraged to park their money in junk debt in exchange for a pitiful 4-5% yield. The economy is sick. The idea of consumers breaking out their wallets and spending like the drunken sailors of 2007 is laughable.

My expectation for the next 6-24 months is that the Fed slowly retreats from talk of hiking rates and into another round of QE. That will mark the final admission that the Keynesian policies aren’t working and where the markets lose all confidence in central banks.

A confidence collapse would slam currency markets, but it should exercise the most severe impact on the commodity currencies that my traders and I focus on with QB Pro. The deflation would press prices even further to the downside, which provides ideal conditions for this type of strategy.

Open slots for new traders

I’m hosting a webinar on November 12 to teach you as much as I can about algorithmic trading. The webinar is going to cover in detail the QB Pro strategy, especially the SB score. I’m also planning to discuss the Fed and Chinese situation in more detail, as these are the two most important factors for us to consider when applying strategies. Make sure to sign up to the newsletter to be notified when I start accepting registrations. This is also open to traders in the United States, which is a big change from previous options!

If you’re interested in trading the QB Pro strategy in your own account, attending the webinar will be mandatory. And as a thank you for spending 45 minutes of your day learning from me, you’ll be given a strong financial incentive to trade QB Pro. More details to come soon, so make sure that you subscribe to the newsletter now before you forget.

QB Pro Update September 2015

October 1, 2015 by Shaun Overton 6 Comments

Back in the black! The return for the month was 1.03%. It’s not a huge gain, I concede, but a win is a win.

The lifetime equity for QB Pro

Performance didn’t really go anywhere this month. We floated 2% above and 2% below zero most of the time.

The QB Pro performance for September 2015 only

QB Yen came in again at a minor loss -0.61%.

The performance for QB Yen only, Sept. 2015

I’m a bit disappointed with the QB Yen performance so far. Nothing seems wrong other than bad timing turning it on on my part. It’s still hard to take it on the chin for 5 months running, though.

The hedge

I manually hedged the portfolio earlier this month by buying USDCNH in a pullback from of all the chaos. The portfolio took it hard when the yuan was loosened up. I figured that any further volatility would likely stem from USDCNH weakness.

The Chinese are actively intervening in their currency. As we all know from the GBP in the 1990s and the CHF this year, interventions work until they don’t. The main point of concern for me is the rollover cost. It is quite expensive to maintain the position.

The thing that makes me comfortable with that trade is that there is no chance of China miraculously healing. It’s in debt up to its eyeballs – everything from corporates all the way up to regional governments. And while China doesn’t want the yuan to devalue too quickly, the absolute last thing it would want is for the yuan to rise in value.

I cannot conceive of any plausible scenario where China manages to return to the 7-10% annual GDP growth that it experienced for 30 years. Too hot, too fast. If you have a plausible scenario in mind, then write your ideas in the comments section.

Updates to the strategy

I’ve promised many updates to the strategy over the past 6 months. Jingwei and I have evaluated them all. All of the proposed changes came up far short of my expectations and were thus not implemented in the live account.

I’m working with Jingwei, our actuary, to develop new trading systems. You’re going to learn the newest indicator in a few months.
Posted by OneStepRemoved.com on Thursday, September 17, 2015

The changes alluded to in the post are all different from QB Pro. I’ve flogged that strategy about as much as I can.

I feel good about QB Pro long term. Before anything potentially good happens in the account, however, I really need the Fed to get off the bench. Raising rates would be good for us because it should kick off a long term USD trend. Another round of QE would be the best thing for the strategy. I personally despise QE and think it’s a bad idea, but it would ignite a massive USD selloff. That’s the kind of market where QB Pro has done extraordinarily well in the past.

Here’s the US dollar index for the past year:

The US dollar index for the past year.

And for easy comparison, here’s the same QB Pro lifetime equity chart. Notice that performance peaked around mid-March and has been flat ever since.

The lifetime equity for QB Pro

Things should pick back up whenever the dollar picks a direction. I expect that to happen by year’s end. Nobody will believe the Fed if they punt one more time on a rate increase in December.

In the meantime, all of this research has given me the great epiphany that the strategy works best where pairs are trending. The portfolio is being rebalanced this month accordingly.