Cross posted with MacroBusiness.
The confluence of events over the past week has taken the wind from the Australian Dollar’s sails and contributed to the drop through support in a manner that suggests this move has further to run. Indeed I have been calling it back below parity for some time now – we just needed support to break and the bulls to give up for a while and head for the hills.
It seems they have done this in uncompromising fashion as you can see in the chart below.
Clearly, the break higher from last week and the week before was a false break which swiftly moved back below the downtrend line and has now broken the last line of Fibonacci and recent support from the rally that began in mid December last year.
For mine on a technical basis we are going for a full round trip to 0.9960 and probably all the way back to the mid 0.90′s region.
But lets look at the set up of the other 4 drivers besides the technicals in our Aussie Dollar Valuation process/model.
Interest Rate differentials - Australia still exhibits a significant risk adjusted pickup to other developed markets whose rates are sitting between 0% and 1% but that gap is closing fast and likely to close substantially further as the RBA strives to bridge the dichotomy between the mining economy and the balance of the Australian economy.
This factor is not negative yet but as rates rally the free ride for holding Australian Dollars and Australian debt diminishes and the capital gain, from positions already on traders/investors and portfolio managers books if these positions are sold, gets ever larger and harder not to take in a world of volatile returns. As investors sell Australian denominated assets the Aussie Dollar will come under pressure. Equally however an absence of new buyers can have the same effect in that the sellers would get the upper hand.
Global Growth – While China’s PMI’s have improved a little the outlook for global growth has deteriorated as the growth profile of the developed world seems to be slipping back once again. Crude dropped precipitously on Friday night after the non-farm payrolls (and labour participation) signalled that the US economy is under pressure again and we all know how moribund Europe is.
This is a negative for the Aussie Dollar and is and will weigh on it.
Investor Sentiment – equities have been climbing a wall of worry for a while now as sentiment has not been overly positive. that is why the Aussie Dollar has been underperforming, indeed selling off, for most of the past couple of months. Sentiment is just not as ebullient as it was in the post-pessimistic crescendo bounce from the lows last October in risk assets.
As asset prices closed in on or exceeded fair value based on reasonable assessment of valuations so this “risk rally” (for want of a better term) has stalled, losing precious momentum.
Non-farm payrolls Friday night along with the election of the anti-austerity new French President Hollande in and the lack of clarity about the future of Greece after the rise of the anti-rescue pact party has seen investor sentiment turn sour in trade today. Whether this lasts or whether this is just the usual Asian session panicky trade to be reversed in the European and US sessions is hard to tell. But my sense is the Bears are going to get to have their time in the sun for a little while now.
USD - when things go south in markets and in the global economy the US Dollar is King. The King is back in the limelight as you can see in the Euro chart above and under present Macro settings the USD looks likely to remain dominant. As the ANZ said in an FX research piece this morning,
The USD is likely to remain on the front foot under this environment. Some concrete action monetary action from the Fed and/or the ECB could act as a circuit breaker, but there is little sign of those policy steps at present. At this stage also we expect the dollar’s strength to remain reasonably orderly;
The USD is the other side of the Aussie Dollar – its strength when it is broad-based will see the Aussie Dollar under pressure. Further the negative feedback loop for the Aussie comes from the fact that the USD is also the other side of most commodities - which are denominated in USD’s – so US Dollar strength at times like these will generally equal commodity weakness putting further pressure on the Aussie Dollar.
So all things considered the outlook for the Aussie Dollar has turned negative in the current environment. I’m not sure how far the fall will go other than my initial expectation of a run down to 0.9960 – it won’t be straight line and we’ll update it on the way lower but for now it looks like Australian business might get some respite from the strong Aussie Dollar.
It is welcome relief though as the settings in the Australian and global economies necessitate it.
Have a great day
Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.
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