Australian Dollar to Fall as Fundamental Outlook Turns Negative Read more: DailyFX -
Posted 06-08-2010 at 10:14 AM by DailyFX
Tags aud, australia, dollar, forex aud/usd
The Australian Dollar is poised to move lower a the interest rate tightening cycle stalls, while a host of longer-term fundamental factors conspire to undermine the currency in the coming months.
The Australian dollar has been among the top performing currencies over the past year. While majors such as the Euro and British Pound have been trending lower for several months amid sovereign debt concerns, commodity currencies, including the Aussie, have been largely insulated, supported by robust global growth on the back of emerging markets such as China. This past month, however, the foundation of the global growth thesis has been shaken, and in turn, commodity currencies have had their most significant fall since the depths of the credit crisis a year and a half ago. Still, we continue to see AUDUSD as overvalued and expect the exchange rate will trend lower in the months ahead.
Over the past month, volatility has picked up considerably in AUDUSD, just as it has in most currency pairs and most financial instruments in general.
The pair has lost 14 percent peak-to-trough over about the same period, having put in a top just below the 0.94 figure. Though the recent move is significant, it is relatively mild compared to the 2008 plunge and subsequent 2009 rebound.
The selloff has been fueled by a broad move out of risk assets and into safe havens such as the U.S. Dollar and gold. Indeed, AUDUSD is perceived to be one of the pairs most closely tied to global growth. Recent movements have tracked the MSCI World Index extremely closely.
There is no reason to think that AUDUSD will not continue to track movements in broad risk sentiment in the near term. Over a longer time horizon, however, AUDUSD should find an equilibrium level that is independent of capital movements. In our view, AUDUSD is fundamentally overvalued and a move toward a sustainable equilibrium exchange rate implies losses, with significant rallies to be considered as opportunities to sell.
From the perspective of external trade, the Australian Current Account deficit narrowed in 2008 and 2009 and is expected to continue shrinking to approximately 3.5 percent of Gross Domestic Product in 2010 on the back of strong commodity pricing, according to the International Monetary Fund (IMF). The trend is expected to reverse over the longer term, however, with the deficit set to increase to over 5 percent of GDP by 2013.
Australian economic activity outpaced that of other advanced economies by an incredible 4.5 percent in 2009, as the economy managed to avoid falling into a recession. However, that growth premium is expected to fall back near 1 percent this year, close to what it has been over the last two decades.
Turning to monetary policy, while the relatively high cash interest rate of 4.5 percent offered by the Australian central bank is well above those maintained by its counterparts in other advanced economies, its ability to remain as a supporting factor for the exchange rate seems suspect. Indeed, after adjusting for inflation, Australia’s yield gap substantially narrows. Based upon this year’s first-quarter annualized Consumer Price Index reading of 2.9 percent, the real cash rate in Australia is about 1.6 percent. Furthermore, the interest rate outlook going forward is less flattering. Based upon a Credit Suisse gauge of policy expectations derived from overnight index swaps, markets are pricing in a mere 10 basis points in rate hikes from the Reserve Bank of Australia over the next year, versus over 30 basis points from the U.S. Fed and ECB. Therefore, widening interest rate differentials are unlikely to be a bullish catalyst for AUDUSD going forward.
Though capital movements will continue to have significant, sometimes overwhelming influence in determining interest rate levels and fluctuations, we believe that the fundamental factors outlined above will serve to push the AUDUSD exchange rate lower. Moreover, movements in capital can work against a currency just as vigorously as they work in its favor. Indeed, that is precisely what we saw in 2008 when AUDUSD collapsed 38 percent over a three month period.
Our medium term target for AUDUSD is 0.70, which is consistent with a normalized current account deficit of 5 percent, a growth premium of 1 percent, and real cash interest rates less than 4.5 percent.
Traders with longer term holding periods can begin to build positions at current levels near 0.81. Above that, there are two levels where we would consider selling AUDUSD incrementally. They are 0.8508, the reaction high of the 5/13-5/25 downswing, and 0.8737, the 200-day moving average and bottom of the first leg down of the current correction.
The Australian dollar has been among the top performing currencies over the past year. While majors such as the Euro and British Pound have been trending lower for several months amid sovereign debt concerns, commodity currencies, including the Aussie, have been largely insulated, supported by robust global growth on the back of emerging markets such as China. This past month, however, the foundation of the global growth thesis has been shaken, and in turn, commodity currencies have had their most significant fall since the depths of the credit crisis a year and a half ago. Still, we continue to see AUDUSD as overvalued and expect the exchange rate will trend lower in the months ahead.
Over the past month, volatility has picked up considerably in AUDUSD, just as it has in most currency pairs and most financial instruments in general.
The pair has lost 14 percent peak-to-trough over about the same period, having put in a top just below the 0.94 figure. Though the recent move is significant, it is relatively mild compared to the 2008 plunge and subsequent 2009 rebound.
The selloff has been fueled by a broad move out of risk assets and into safe havens such as the U.S. Dollar and gold. Indeed, AUDUSD is perceived to be one of the pairs most closely tied to global growth. Recent movements have tracked the MSCI World Index extremely closely.
There is no reason to think that AUDUSD will not continue to track movements in broad risk sentiment in the near term. Over a longer time horizon, however, AUDUSD should find an equilibrium level that is independent of capital movements. In our view, AUDUSD is fundamentally overvalued and a move toward a sustainable equilibrium exchange rate implies losses, with significant rallies to be considered as opportunities to sell.
From the perspective of external trade, the Australian Current Account deficit narrowed in 2008 and 2009 and is expected to continue shrinking to approximately 3.5 percent of Gross Domestic Product in 2010 on the back of strong commodity pricing, according to the International Monetary Fund (IMF). The trend is expected to reverse over the longer term, however, with the deficit set to increase to over 5 percent of GDP by 2013.
Australian economic activity outpaced that of other advanced economies by an incredible 4.5 percent in 2009, as the economy managed to avoid falling into a recession. However, that growth premium is expected to fall back near 1 percent this year, close to what it has been over the last two decades.
Turning to monetary policy, while the relatively high cash interest rate of 4.5 percent offered by the Australian central bank is well above those maintained by its counterparts in other advanced economies, its ability to remain as a supporting factor for the exchange rate seems suspect. Indeed, after adjusting for inflation, Australia’s yield gap substantially narrows. Based upon this year’s first-quarter annualized Consumer Price Index reading of 2.9 percent, the real cash rate in Australia is about 1.6 percent. Furthermore, the interest rate outlook going forward is less flattering. Based upon a Credit Suisse gauge of policy expectations derived from overnight index swaps, markets are pricing in a mere 10 basis points in rate hikes from the Reserve Bank of Australia over the next year, versus over 30 basis points from the U.S. Fed and ECB. Therefore, widening interest rate differentials are unlikely to be a bullish catalyst for AUDUSD going forward.
Though capital movements will continue to have significant, sometimes overwhelming influence in determining interest rate levels and fluctuations, we believe that the fundamental factors outlined above will serve to push the AUDUSD exchange rate lower. Moreover, movements in capital can work against a currency just as vigorously as they work in its favor. Indeed, that is precisely what we saw in 2008 when AUDUSD collapsed 38 percent over a three month period.
Our medium term target for AUDUSD is 0.70, which is consistent with a normalized current account deficit of 5 percent, a growth premium of 1 percent, and real cash interest rates less than 4.5 percent.
Traders with longer term holding periods can begin to build positions at current levels near 0.81. Above that, there are two levels where we would consider selling AUDUSD incrementally. They are 0.8508, the reaction high of the 5/13-5/25 downswing, and 0.8737, the 200-day moving average and bottom of the first leg down of the current correction.
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