‘Very Crowded’ Aussie Hedge Fund Trade Faces Key Market Test

(Bloomberg) -- Yet another hot hedge fund trade in Asia Pacific faces a crucial test after short-yen wagers backfired in a spectacular way last week.

Traders have been snapping up options betting Australia’s dollar will outperform its New Zealand rival since late June, amid speculation the former will hike interest rates to tame price pressures while the latter will cut them. The Aussie has obliged with a near 2% rise this month and traded at over 1.11 kiwi dollars on Monday.

On Wednesday, investors get key data showing whether Australia’s core inflation will come in above or below central bank forecasts — an important gauge of its progress in cooling prices. Signs of sticky inflation would boost Aussie bulls.

“The Aussie-Kiwi call trade is indeed very crowded,” said Alvin Tan, head of Asia FX strategy at RBC markets. But the pair is vulnerable to a reversal if Australia’s price pressures ease, and a break below 1.10 could spur profit taking, he added.

The data are an extra catalyst in a busy week after a wild few days in the foreign-exchange market, after bets on a more hawkish Bank of Japan eroded the appeal of popular short-yen positions and turbo-charged a rally that weighed on regional currencies. Rate decisions from the BOJ and the Federal Reserve and the outcome of a gathering of China’s top politicians are set to add to Asian currency market volatility.

Strong Australian employment figures combined with the nation’s sticky inflation rate have encouraged traders to price in the possibility of RBA hiking interest rates again this year. The trimmed mean consumer price index, a core inflation measure, is forecast to remain stuck at 4% in the second quarter — above the RBA’s forecast.

Meanwhile in New Zealand, swaps traders are pricing in about a 66% chance that the central bank will cut rates during its policy meeting next month, amid growing risk the economy may fall back into recession.

Leveraged funds have been building bullish Aussie-kiwi options positions, primarily with one- to three-month expiries, traders said in mid-July, asking not to be identified because they weren’t authorized to speak publicly. Short-term funds were also buying the currency pair directly in the cash market, they added.

“Our read is that the Aussie-Kiwi cross is in the midst of a medium-term bullish reset to higher ranges,” said Richard Franulovich, Sydney-based head of FX strategy at Westpac Banking Corp. However, “the short-term caution has to be that second-quarter Australia consumer price index does not make a case for an RBA hike.”