BAFI1018: After taking the time to understand the foreign exchange market and analyzing the fundamental drivers behind: International Finance Report, RMIT, Singapore

After taking the time to understand the foreign exchange market and analyzing the fundamental drivers behind the four designated currency pairs that were provided in this scenario, we have constructed a weighted portfolio comprising currency pairs with varying degrees of significance. We have decided to equally allocate two of our most significant weightage for the currency pairings EUR/USD and AUD/USD with each comprising 30% of
the portfolio, 25% to USD/JPY, and the remaining 15% of the portfolio to GBP/USD.

Taking a broader perspective, as it stands, the EUR/USD has been trading within a consolidation since mid-May, with recent data showing that the unemployment rate in the US declining to 3.9%. The focus in terms of US economic data however will be inflation; the latest Consumer Price Index (CPI) figures are scheduled for release this Friday. With unemployment falling (as observed from recent data) and GDP rising in the US, the current inflation reading might appear exceptionally strong as analysts are expecting CPI to remain unchanged at 2.9%.

We hold the view that CPI in the US will come in high, setting up an opportunity for a long position in the EUR as prices of goods in the US are expected to increase. This notion is also supported by fears concerning the US waging a trade war against China; the US President has threatened to raise tariffs from 10% to 25% on Chinese goods. In retaliation to this, China has also imposed tariffs against US goods and consequently the devaluation of the Yuan. These actions by two economic powerhouses consolidate the likelihood of the USD depreciating, with the EUR gradually garnering steam over the next few weeks.

The AUD/USD currency pair, also known as the ‘Aussie’, is one of the most popular currency pairs traded in the world. Aside from the interest rate factor, the trade balance of a country could briefly indicate the nation’s standing and allows us to take a view of the currency. The Aussie is currently traded at AUD$0.73 with its trade balance currently at a surplus, a 13-month high at a staggering AUD$1.87 billion in June from AUD$0.73 billion in
May (Trading Economics, 2018).

On the other hand, the US trade balance is currently at a deficit of USD$-46.3 billion as of June 2018 and has further widened from USD$-43.2 billion previously. A trade surplus would normally be perceived as a net inflow of the domestic currency from foreign markets, thus increasing the value of the domestic currency as a positive demand for AUD exists. We expect that the AUD would appreciate trading at AUD$0.71 against the USD towards the end of Q4. On the other hand, we would expect the USD to depreciate slightly against the AUD in the near future due to its large trade deficit.