Quote:
Originally Posted by Freefox
Hello John,
Just found this thread and it's a very informative read. I'm a beginner when it comes to fundamentals and would really like to understand more about this area, in particular by use of an example so as to consolidate my knowledge and understanding.
AUD/CHF is currently trading at approx. 0.9100. This currency pair is obviously a candidate for the carry trade with a high yielding currency against a low yielding one. However, looking at the projections for the interest rates for the two countries over the medium term (say a year out), the expectation is for the Aussie interest rates to continue to be cut whereas the Swiss is expected to be stable (or possibly upwards next year).
Based upon a falling interest rate and a stable to rising one, am I right in saying one would expect the Aussie dollar to weaken against the swiss and start moving downwards, say towards a .8500 exchange rate? Therefore, the carry-trade involvement would start to be unwound between the 2 currencies.
However, I read that the Aussie is strongly correlated with the commodities, particularly gold. Gold over the past week has been making some very strong up moves and could be resuming it's longer term up trend thus if the correlation remains this would give strength to the Aussie dollar rather than the weakness I describe above. How does one interpret these apparent conflicts in the Aussie dollar v ths Swiss Franc and come up with projections as to where a currency is likely to head, based upon a fundamental stand-point?
Where is the AUD/CHF pair likely to be trading in saying 3-6 months and a year out given the above apparent conflicting scenarios?
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Hello Freefox,
Good questions.
The medium term interest rate outlook (which most industrialized central banks target) for both central banks is indeed matching your suggestions. The RBA is expected to shave another 100 basis points off its benchmark and the SNB is expected to keep its target range unchanged through the coming year.
Everything else being equal, we would expect these rate forecast to lead to the Australian dollar depreciating against the franc. However, this isn't an 'everything else being equal' world; so we need to factor in what a fair value for this exchange rate would be before rates were adjusted and after they were adjusted to reflect expectations. Even if the RBA does cut a whole percentage point off its benchmark, it would still be well above the Swiss figure; so there is going to be a point where it comes to equilibrium.
As for introducing commodity prices, that is another, unique pricing dynamic (there are thousands if not millions of different fundamental factors to take into account). Commodities are an important driver for the Australian dollar because the country is one of the largest producers of coal, gold, cattle and many other natural resources; and when you buy those goods from them, you first need to exchange your currency.
However, the correlation holds more closely to those pairs that include major consumers and producers of said commodities. That's why AUDUSD holds such a correlation thanks with the US representing the largest consumer of natural resources. For AUDCHF, that correlation is much weaker.
You definitely need to determine the influence each factor will have on currency pair. AUDCHF is primarily guided by rate expectations - by a wide margin. However, there is still a correlation to commodities; but that is because there is more of a speculation component to commodities as well - as traders use some goods like gold to hedge interest rates and growth.
All that being said, I wouldn't suggest anyone trade a carry in one pair. The leverage could easily force a margin call as capital gains and losses are far greater than any daily carry. Instead, one needs to be diversified in at least 4 (that is a number we have found does most of the diversification) carry trade pairs. But even then, you still have a discretionary call on risk appetite.
