AUD/USD finding support from unusual stability in USD/CNH

• AUD/USD managed to bounce on Tuesday despite further US dollar strength
• Gains in Chinese equity index futures and stability in USD/CNH may be limiting downside near-term
• RSI (14) diverges from price, hinting directional risks may be turning

Overview

Gains in Chinese equity index futures and relative stability in the offshore-traded Chinese yuan may have shielded the Australian dollar from the latest bout of US dollar strength, helping AUD/USD push higher on Tuesday despite the risk-off tone across broader markets. Sitting in what looks to be a falling wedge pattern, the Aussie’s next directional shift may be higher.

AUD/USD remains a China proxy

While AUD/USD can’t entirely escape the influence higher US Treasury yields are having on FX markets, seeing capital shift from other parts of the world into the US dollar, it’s obvious it’s still being used as something of a China proxy among traders based on the rolling 10-day correlation coefficient scores below.

It’s noteworthy how strongly inverse the AUD/USD relationship has been over the past fortnight with USD/CNH, sitting with a score of -0.9 which indicates the two have usually moved in the opposite direction over this period.

In contrast, the score with USD/JPY has been considerably weaker at -0.72, hinting AUD/USD may be more influenced by sentiment in Chinese markets than purely US interest rates which tend to drive the Japanese yen.

Further bolstering that view, the AUD/USD has seen relatively strong correlations with Hang Seng futures and other China-linked markets such as crude oil and copper.

USD/CNH upside grinds to a halt

Remembering AUD/USD has seen a stronger relationship with USD/CNH than USD/JPY over the past fortnight, it’s interesting to see just how much the Chinese yuan has outperformed the Japanese yen against the US dollar over the course of this week, barely budging against the greenback despite continued softening in JPY.

While there’s been no obvious evidence of it as yet, during past episodes of rampant US dollar strength Chinese authorities rolled out numerous measures to prevent large-scale weakening in the yuan, either through stronger onshore CNY fixes, outright dollar sales from state-owned banks, or sales of short-dated yuan securities to drain market liquidity, making it far more expensive to short the Chinese currency.

If that is taking place right now, it may provide AUD/USD with some form of buffer that may limit downside given its relationship with the yuan.

AUD/USD directional risks turning higher?

Looking at AUD/USD on the daily chart, the price looks to be sitting in a falling wedge pattern with the pace of its unwind slowing noticeably over the past two weeks. With RSI (14) printing higher lows, diverging from the trend in price, momentum may be slowly starting to turn, pointing to the potential for renewed upside.

We’ve already seen one false topside break of the wedge, but with the momentum picture starting to turn, another break above the level could prove to be more successful.

If we were to see a push above the downtrend currently located at .6695, traders could initiate longs with a tight stop below for protection. The first topside target would be .6723, the high set on Monday. If that were to give way, the 50DMA, .6760 and long-running downtrend resistance around .6830 are other possible targets depending in the risk-reward you’re looking for.

-- Written by David Scutt

Follow David on Twitter @scutty