Ever since China's stock woes escalated it seems all commodity-related trades have sunk under water. The Aussie took a nose dive vs. the two dominant safe havens, i.e. the US Dollar and the Japanese Yen, and turned range bound vs. the Kiwi.
In the not too distant past, there had been some signs of a tentative recovery in the Aussie. However, those signs quickly became mixed messages, offering nothing but false hope. Simply put, China continued to lose its grip on its financial system. Now, as always, China has been the wild card for the Aussie. We've already elaborated on the fact that China can't keep the Yuan high; at best, it can only slow its depreciation. But can China's latest actions be the springboard for the Aussie to rally?
China's Slow Trickle Down Impact
Thus far, China has been inconsistent in its reaction to the crisis, which at one point included direct intervention in the stock market. Nevertheless, the latest moves suggest that perhaps China's leadership finally realizes what it needs to do. The most recent moves have been focused on two fronts.
The first front is to gradually, yet delicately enforce capital controls in order to avoid hysteria. That would successfully curb the massive capital outflows from the country. This has been done by publicly forbidding major corporations from selling large quantities of stocks. Behind the scenes, Beijing may have conducted some "arm twisting" in order to avoid massive Yuan selling.
According to the latest news, Beijing has put an end to the Qualified Domestic Limited Partner (QDLP) scheme. The QDLP scheme would have allowed Chinese citizens to invest in international markets through the Shanghai Free Zone. That move appears to be yet another of the government's "behind the scenes" measures towards tougher capital controls.
The second front is aimed at China's homeland capital flows, meaning credit. While China wants to curb capital outflows outside the country, it also wishes to ease the flow within the county. Hence, the latest news shows that the People's Bank of China lowered the reserve requirements for Chinese banks to 17%. That would allow more lending activity and credit growth.
If the Chinese government continues to move resolutely in that direction, we might finally have some level of confidence restored. And the restoration of trust sets the stage for some stability in China's economy. But it is difficult to see confidence returning to pre-meltdown levels anytime soon.
Given that China is Australia's largest trading partner in terms of demand for commodities, that's a positive thing. If China's economy does begin to stabilize it will eventually trickle down to the Australian economy and the Aussie.
Of course, there is a caveat. That process will be slow and the current commodity glut is set to continue and will weigh on the Australian economy. The transition from restored confidence to expansion mode is not quick. The Australian job market still looks weak as unemployment levels continue to jump while the trade deficit widens. All the while, inflation levels are held somewhat steady due to the weaker Aussie.
Game Plan For The Aussie
It's true that the Australian economy will continue to face headwinds. It's also true that the rising likelihood that China will inch towards stability will impact the Aussie only in the longer term. Those facts, however, tend to ignore the speculative elements that will come into play.
For example, the Reserve Bank of Australia obviously is keenly watching developments in China. Those developments, albeit slow moving, could turn the RBA much less dovish. Naturally, Aussie traders will quickly pick up on that and that could unleash some speculative bets on the Aussie vs. its peers. Those peers are primarily the JPY and the Euro, both of which are trading in a negative rate environment.
Naturally, all FX investments have a speculative element. But in this case, if the RBA does turn less dovish, perhaps prematurely given a lack of evidence, it could mean a quick yet limited rebound. That is until the evidence does finally emerge.
However, bear in mind that the RBA has a tendency to take strong cues from China. Thus, a surprisingly less dovish or perhaps slightly hawkish statement from the RBA could be forthcoming any time now. And that means that Aussie traders should keep a close eye on the next few RBA meetings.
Look for my post next week.
INO.com Contributor - Forex
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.