Citi Trade of the Week: Short EUR/AUD

Trade idea: Sell EURAUD at 1.4120, target 1.39, stop loss 1.4250

Our view:

Carry could see stronger performance this week. The modestly disappointing payrolls release could be associated with lower volatility since it confirms the strong trend in labor markets but does not threaten very benign expectations on the Fed. Indeed, the outcome could reinforce perceived tail risk on later tightening, with June now seen as out, September in play but not guaranteed and December/never a growing possibility. Given elevated market expectations on this week’s retail sales release, a similarly good but not great outcome could reinforce lower volatility. Combined with China’s weekend easing this should be favorable for higher carry currencies such as AUD.

Positioning may be conducive to AUD gains. Price action on Friday saw AUD shrug off the impact of lower RBA forecasts in the Monetary Policy Statement. This suggests that investors may be inclined to cover shorts on dips, which could skew risk-return in favor of gains moving forward. Our flow data shows some AUD buying by the leveraged sector in recent weeks, but this follows a period of sustained selling so there should be more room for investors to cut shorts. In the real money sector, buying interesting has been steady for the duration of 2015. This could reflect perceived value in AUD among longer-term investors given the relatively high yield/credit status and in the wake of earlier losses. A rise in risk-appetite and decline in volatility amid a pause in USD appreciation is only likely to reinforce this flow from longer-term investors.

EUR should be an attractive vehicle for carry trades. While EUR has benefitted from short covering fueled in part by increased optimism on the political situation in Greece, better sentiment could be tested today (and later this week) by a failure to make progress at the Eurogroup meeting. Renewed drag from politics could leave EUR vulnerable to underperformance.

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