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Pitting the U.S. Against China

We can't play such a currency pair directly -- but we can certainly wage a proxy battle.
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Last week, I wrote about the U.S. dollar and its current unpredictable nature. The greenback has continued its recent pattern of higher highs and lower lows, indicative of a series of failed breakouts that have frustrated both bulls and bears. It's a tough situation, and one that I prefer to avoid.

One currency that's on a more predictable path is the Australian dollar. On Thursday night, China's Finance Minister Lou Jiwei wrecked the Australian currency, along with the hopes of China bulls who had been betting on a bounce in the world's second-largest economy. Lou suggested that slower growth would be an unfortunate side effect of China's plan to reduce its dependence on exports, and the assumption is that this will have a knock-on effect for Australia.

Referring to gross domestic product growth, Lou rocked markets with this statement: "We don't think 6.5% or 7% will be a big problem. . . . Please don't forget that our expected GDP growth rate for this year is 7%."

China recently lowered its growth target to 7.5%. Did Lou confuse China's target for annual expansion for this decade -- 7% -- with its 7.5% target for the year? Or has this year's target rate been lowered again? China's official second-quarter GDP is scheduled for release Sunday evening -- and the fact that Lou even mentioned 7% growth leads me to believe he is prepping markets for bad news. Now, thanks to Lou, markets probably won't react too violently if second-quarter GDP growth comes in at 7.2% or 7.3%.

All of this has the Australian dollar threatening to break to new lows yet again. Aussie is hanging on to $0.9000 by a thread, and has formed a bearish descending triangle. The currency is on the verge of losing the $0.9000 handle for the first time since the fall of 2010.

Source: TradeStation

I'm loathe to short the Aussie-U.S. dollar currency pair because of the greenback's erratic nature, as mentioned above. An alternative play, then, might be to short the Aussie-Canadian dollar cross.

Think of Australia and Canada as two stores that each rely mainly on one major customer. Australia chiefly supplies goods for China, while Canada provides a similar service for the U.S. We can't bet on the U.S. vs. China directly via currencies, since China's yuan doesn't float freely. But we can trade their respective suppliers against one another.

Source: TradeStation

The play here is to short the Australian dollar vs. the Canadian dollar on a rally to the 0.9500 area. That level had been support on what is now a broken descending triangle. The Aussie-Canadian dollar pair is even weaker than the Aussie-U.S. dollar cross: The former has already broken support, while we're still waiting for the latter to break down.

Place the stop above the 20-day moving average (green), located at 0.9627 at the time of this writing. This moving average has acted as resistance on five separate occasions since June 26 (arrows).

In doing this, we not only remove the U.S. dollar from the equation, which we hope will result in a smoother ride, but we also play two commodity currencies against one another. The major difference between the two is that Canada is a net exporter of oil, and Australia is not. Oil prices are on the move right now, so this gives the Canadian dollar another edge over the Aussie.

At the time of publication, Ponsi had no positions in the securities mentioned.