Weekly AUD Wrap

July 18, 2011

FOREX

I haven’t had time to do a full market wrap over the past couple of weeks and for that I apologise. But here is the AUD wrap I posted over at MacroBusiness on Saturday morning.

Another week of the Aussie dancing on the spot as it traded inside the range once again. Excuses abound for Aussie selling but it continues to hold in relatively well all things considered.

We had a good chat in the comments section after yesterday’s piece on the tussles between the bulls and bears in the Aussie. The discussion in the two articles highlighted in that blog and then in the comments section of the same blog pretty much summarises why Aussie is range bound at the moment.

That is, the bulls see a rerating and a commodity and China story while the bears see risks to the China story, think the notion of a rerating is a myth, and its only a matter of time before the Aussie resumes normal production and falls again.

My personal view it that there has been a rerating but the strength of this is yet to be tested because for all the volatility and hand wringing in markets globally over the past few months we haven’t really sseen the type of risk aversion emerge that would be necessary to set-up for an Aussie precipitous drop.

So we can’t judge yet whether the Aussie is just the beneficiary of current market consditions or if it really will be better supported if markets tank.

But we do know that there are many more long term buyers in the Aussie than there were in the past. These buyers, such as central banks, wouldn’t usually be spooked out of their trades anytime soon. But if I play Devils Advocate for the bears (only because Aussie is still so high not because I think they are the bad guys) we can make a case that perhaps there is something in their logic.

Let’s summarise why the Aussie is so high at the moment:

An extremely weak USD as you can see in this chart of the US TWI – this is driving Aussie higher. BIG TICK√

China – the fact that China, and Australia, has been able to weather the GFC better than most and the fact that China is still only in the first quarter of its game of urbanisation gets people excited about their enduring appetitie for Australia’s exports and the income boost this will have on our economy. The RBA is on the record saying China is a multi-decade boom and that their GDP growth is now more important for Australia than that of the USA. BIG TICK√

Australia itself – offshore investors were skeptical about Australia, our housing market and the economy’s ability to weather the storm in global finance without a recession. But we did and we have. BIG TICK√

Interest rate differentials – because we have done so well and because the RBA thinks (or thought) there was a mining boom induced income boost coming they have tightened rates. Nice pick-up for “real money” investors bond funds and great return for the carry traders.  BIG TICK√

Commodity and global growth – Even though the developed world has been weak the axis of growth has shifted to China and the developing world so commodities are still up and we sell heaps of them. BIG TICK√

Investor sentiment or risk appetite – QE2 has pumped up the tyres of so-called “risk” (I prefer punting) assets and the Aussie has been the beneficiary of that. BIG TICK√

All pretty good but you can see the bear case pretty clearly there as well. Abstracting the USD weakness because I still can’t figure out what I think happens if they get downgraded (I’m not sure it matters in a world where the alternatives – EUR and JPY – are moribund) there are obvious risks to the outlook.

  • China could misstep or crash;
  • The end of QE2 defaltes ‘risk” assets;
  • Investors finally wake up from their sanguine dreaminess and see the reality that faces them and start selling equities and reduce their risk exposure;
  • This takes commodities lower; and
  • Investors wake up to the reality that the Australian economy is in a bit of a state. The boom has not and is not washing through the economy and consumption is weak at a household level. Bill Evans has now flipped the Westpac call to cuts reflecting a recognition of what the MacroBusiness team has been saying for some time so interest rate differentials may close and more importantly the housing and consumption negative feedback loop could intensify bringing focus on the Australian economic miracle bubble bursting.

But, at the moment the positives predominate. The reality is that the Aussie near term outlook remains ok unless or until markets dislocate. Then and only then can we really judge if it has been rerated or not. I can envisage a move back to .97 over coming months even if we see a continuation of recent volatility, but no break down,  then it should hold in ok and find support and buyers. If we see a return to the benign markets of the pre-April 2011 period before the recent turmoil then the outlook once again turns positive.

It’s all a question of your time frame and your approach. To trade this Aussie at the moment you must get that and your position sizing right – otherwise you’ll just be donating your capital to Mr Market.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

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.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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  1. Gold Standard Australian Dollar | Lighthouse Securities - July 26, 2011

    […] Saturday’s ago I walked through the 5 drivers and showed just how positive the whole toolkit is for the Aussie at the moment when we sum up the […]

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