Aussie dollar is world's best-performing major currency

Hedge funds may have picked a bad time to add to bets against Australia’s dollar, this month’s best-performing major currency.

Commodity Futures Trading Commission data showed large speculators increased positions wagering on Aussie declines by 83 percent in the space of three weeks to a net 66,464 contracts as of Nov. 17.

That’s the most since a record short bet on March 10, when bears were caught on the wrong side of a 6.4 percent rally over two months.

Also read: Why the Aussie dollar will move higher

The currency has climbed at least 0.8 percent against its Group of 10 currency peers this month and measures of exchange-rate and equity market volatility are below this year’s averages.

“The potential for a bigger squeeze is very much alive and kicking,” if the futures data reflects overall market positioning, said Ray Attrill, co-head of currency strategy at National Australia Bank in Sydney.

“What’s under-appreciated is the role that volatility plays in the Aussie and the fact that vols are back down near the lows. On that basis alone Aussie is undervalued rather than overvalued here.”

Calmer October

A measure of calm returned to markets in October following a turbulent two months during which the surprise devaluation of the Chinese yuan and a delay in U.S. policy tightening roiled equities and currencies.

Lower expectations of price swings have benefited the higher-yielding Australian dollar, as have reduced prospects for central bank easing.

After adjusting for volatility, borrowing U.S. dollars to buy the Aussie earned 1.2 percent this month, the most among G-10 currencies, based on the Sharpe ratio.

The currency was at 71.92 U.S. cents as of 9:30 a.m. in Sydney on Tuesday, 0.8 percent stronger than its Oct. 30 close.

Also read: Why Australia's low inflation is a game changer

Implied volatility over three months closed at a four-month low of 11.09 percent on Nov. 20.

The premium investors pay for the right to sell the Aussie versus the greenback over contracts to buy dropped to 0.8 percentage point on Monday, the least since July 2014, according to one-month risk-reversal rates.

The Australian dollar’s resilience is drawing Asia’s wealthy, anxious about the potential for further depreciation in their local currencies, according to UBS Group, the world’s largest private bank.

While the Aussie may weaken to 68 cents, levels near 70 cents would be an attractive entry point to buy, Kelvin Tay, regional chief investment officer at UBS’s wealth management business in Singapore, said last week.

Commodities Slumping

The Aussie has been battered over the past year -- sliding 17 percent -- with investors selling as concern about a Chinese slowdown dented raw material prices. It has broken free of that link to commodities this month, moving higher even as Australia’s key export iron ore dropped 10 percent since Oct. 30.

“Commodity prices are a red flag and we continue to look for rate cuts from the RBA in 2016, which leaves us bearish” on the Australian dollar in the medium term, Joanne Masters, a strategist at Australia & New Zealand Banking Group Ltd. in Sydney, wrote in a research report on Monday.

“The near-term picture remains mixed.”

Given the extreme short, the Aussie risks a move higher this week with Reserve Bank of Australia Governor Glenn Stevens due to speak Tuesday and capital expenditure data Thursday that may cement forecasts for stronger third-quarter growth, NAB’s Attrill said.

Also read: Aussie dollar to hit pre-GFC lows

Policy makers in Australia have signaled they are content with current rate settings and Stevens said Nov. 3 economic prospects “had firmed” in recent months.

The probability of an interest-rate cut by the end of May was 42 percent on Monday, swaps data compiled by Bloomberg show.

At the end of last month, traders had priced in at least one cut and about a 50 percent chance of a second easing.

“Australia is not just an exporter of bulk commodities, but an exporter of tourism and education and financial services and all of those things are doing better because the currency has been weaker,” said Patrick Bennett, a strategist at Canadian Imperial Bank of Commerce in Hong Kong.

“It’s increasingly a situation where you want to buy weakness in the Australian dollar rather than looking for it to collapse further.”