The dollar's dependence on Chinese economic activity appears to be waning, adding weight to the view that the currency is due for a depreciation.

When China’s HSBC Flash Manufacturing PMI came in stronger-than-expected and at the highest level since March 2011, it was just assumed the Australian dollar would be bid higher in response.

Why wouldn’t it? For years, the Aussie has always responded positively to strong Chinese data. That’s just what happened.

However, something’s changing. The historical positive correlation between the Australian dollar/commodity prices/China looks to be under threat.



Source: IG Markets

As you can see in the above chart, the Australian dollar initially popped higher following the release of the figures before undergoing a significant sell-off through the European and US sessions.

In my eyes, this marks a significant change in sentiment.


Source: IG Markets

From a bigger perspective, the weekly chart above shows that the bulls have now tried and failed on more than four occasions to push the dollar through the $US1.06 region. For whatever reason, there is a serious amount of selling around that figure which continues to overwhelm the buyers.

Having said that, we’ve yet to see the sellers actually manage to push the dollar much lower; they are merely capping the upside at the moment and keeping the dollar in a very tight range.

That range is slowly tightening and we will come to a point in the not-too-distant future where we’ll see a break out. The problem is picking in which direction.

My belief is that it will head lower, although there is always the chance it spikes higher first to suck in all the bulls before finally turning down.

I’m not the only one who believes we’ll see a gradual unwind in the Australian dollar over the next year or two. Of 47 forecasters on Bloomberg, the consensus forecast for the end of 2013 and 2014 is $US1.03 and $US1.02 respectively before slipping lower to $US0.94 by the end of 2015.

The thesis behind my thinking is that, firstly, it’s a very crowded trade and I just can’t see who is left to buy.

Secondly, the world is slowly becoming more risk tolerant and hence money is already beginning to flow from safehavens to riskier assets (the euro and stocks for example).

And, finally, yield differentials between Australia and developed nations has bottomed.

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