Throughout the U.S.-China trade war, we have witnessed steel prices continue to weaken, while iron ore prices have surprisingly rallied on a global supply crunch that has seen prices rise to the highest level since 2014. This may indicated hysteresis.

Iron ore's more above $100 per ton is mainly supported by the supply disruptions from Brazil and Australia. According to a senior Brazilian official, Brazil's supply will be down approximately 10% in 2019, and the outlook for 2020 is unclear. With the risks for further shocks, iron ore prices could be supported in the short term.  

Sanford C. Bernstein & Co. is predicting that the world's best miners including Vale S.A. (VALE) will deliver approximately 283 million tons this quarter, a 10% decrease on the year. Iron ore's shortfall will likely continue to support miners including Fortescue Metals Group Limited (FSUGY), Cleveland-Cliffs Inc. (CLF) and Anglo American PLC's (NGLOY) Kumba Iron Ore Ltd.

The last surge in iron ore prices stemmed from a fall in port holdings in China, which have now fallen to a two-year low. While the shortfall could see supply return in the latter half of the year, in the short term, iron ore prices could be supported.

Performance of iron ore and the Australian dollar vs. the U.S. dollar
Bloomberg Finance L.P.

The correlation between the Australian dollar and iron ore prices indicates that we could see the commodity currency rebound if we see another leg higher for iron ore. 

The Australian economy is tightly tied to China, and the current trade war between the world's two largest economies as well as with the recent escalation in tensions have seen most risk asset remain heavy. The Aussie dollar is vulnerable to trade war updates since China buys about one-quarter of its exports from the land down under, especially industrial commodities such as iron ore and coal. 

Recent declarations and data from the Reserve Bank of Australia (RBA) have firmly cemented expectations that the central bank is poised to deliver another rate cut. With declining inflation and unemployment rising, the next decision should be an easy one for the RBA.

While we could see a similar outcome to what we saw from the Reserve Bank Of New Zealand, which decided to deliver a cut and be done for the foreseeable future, the RBA could deliver a cut and adopt a wait-and-see approach to determine if the trade war ends up with a catastrophic outcome. The easier path is for a move lower with the Australian dollar, but we could be nearing a key bottom.

Australian dollar vs. U.S. dollar orderbook
OANDA

The OANDA orderbook shows that clients are already piling onto long positions in the Australian dollar. This weekend's parliamentary elections could see modest volatility to start the trading week, but even if we see a change in government, the rally for the Australian currency could be limited.  

It will be hard to become bullish on any commodity currency or the Australia and New Zealand equities indexes without a trade deal agreed between the U.S. and China. The base case remains that we see a deal done by the end of next month, and if that is the case, the Australian dollar could outperform its peers over the next couple of weeks.

Performance of the Australian dollar vs. the U.S. dollar

Price action on the chart of the Australian dollar vs. the U.S. dollar shows that the recent slide could see key support around the 0.6800 level. It is around that area that the price could set up a bullish butterfly pattern. This chart pattern will disregard the flash crash low that printed at the beginning of the year. If valid, the price could see a significant rebound after making fresh lows. A break of 0.6750 could see bearish momentum accelerate and target the 0.6675 region.

The contents of this article are for general information purposes only and do not take into account a client's personal circumstances. It is not investment advice or an inducement to trade. Examples shown are for illustrative purposes only and may not reflect current prices. Clients are solely responsible for determining whether trading or a particular transaction is suitable for them and for seeking professional advice.