Australian Dollar – Head Fake?

August 10, 2011

FOREX

There is no denying that the AUD, when it wants to, is a volatile beast, when the buyers clear out it simply crashes. Yesterday was a case in point and while the AUD was clearly crashing with other risk assets there was definitely a buyers strike after whoever was defending 1.00 (potentially the RBA) stepped away.

Indeed the low of 0.9928 was synchronous, almost to the minute, with the bounce in S&P futures in night trade as you can see in the chart above.  The AUD/USD is the white line, S&P 500 futures the red line and AUD/CHF the light blue line at the bottom.

So it’s all about risk aversion and investor sentiment at the moment – and we know this is an ephemeral beast.

Yesterday we had a quick run through the 5 Drivers in our AUD model to assess the outlook – which on balance is bearish. But given the magnitude of both the selloff and bounce this week it is worth posing the question of how sustainable is this current Australian Dollar bounce.

Now obviously on the back of the chart above and recent market price action and correlations you’d probably argue, and be right, that at the moment the AUD’s life and future is not its own.

But is it a Head Fake?

The first thing to do is recognise what is driving the AUD at the moment. I can walk you through the 5 Drivers all I want and I can hold that based on this model the outlook should remain that the AUD needs to test trendline support at 0.9700 to see just how strong it really is. That remains my view, particularly given the global growth outlook flagged by the Fed overnight in its announcement that rates are effectively zero forever – at least in market timeframes.

But as I wrote this morning you have to ask the question of what a long term commitment to zero interest rates is going to do to asset markets around the world.

For mine what the Fed is doing is what it has done since the dim dark days of the initial period of the GFC – it is punting (not too strong a word I think) that if it leaves rates low enough for long enough and markets can contain themselves then they are buying the real economy time to heal.

This is a Grand Experiment in my view but one that I believe they have little choice in making. The best case scenario given all of the headwinds that face the US and global economy is in many ways a Japanese style period of low rates and low growth but with slightly elevated prices or inflation. Something akin to what they are doing in the UK with 4% inflation and low growth. In that way stability and certainty can return to the economy, inflation can eat away at the “real” value of the debt pile and the economy can heal itself….

The Fed is doing is trying to skirt the mire by buying time for the economy but as you can see from the  FOMC statement last night that the Fed is hardly enthusiasatic about the prospects for jobs and growth in the short term.

But 3 Fed Presidents on the voting panel at the FOMC dissented from the decision and are not even sure that this fresh commitment to low rates is appropriate. This level of dissent is a sharp example of the ongoing debate between the left and the right in the US about many things economic and makes it problematic for the Fed to wriggle between the factions to get the outcome, let alone consensus it needs.

So ultimately I think the Grand Experiment will fail to ignite growth.

I also think we could be in for a period where the Fed policy gets the old “free money, buy risk assets” trade back on the table. Indeed Bloomberg reported today that,

Asian officials battling inflation pressures see “hot money” risks reviving as the U.S. Federal Reserve said it will keep interest rates at record lows through mid-2013 and pledged additional measures if needed. 

Capital flows to emerging markets “could continue to complicate monetary policy,” Philippine central bank Governor Amando Tetangco said in a mobile-phone message today. In China, the National Development and Reform Commission said that any further quantitative easing in the U.S. may boost inflows of funds and commodity costs. India’s finance ministry and Indonesia’s central bank echoed those concerns.

This means that we could get some perverse outcomes where the usual reaction of commodities and the AUD to weak global growth and a weakening outlook is distorted by free money and a weaker USD undermined by Fed policy.

But do I think the Fed’s action is going to ignite a sustainable move higher where the markets can ignore economic weakness long-term in such a way as to take equities and the AUD back toward recent highs?

No, I do not.

After the massive bounce in the AUD and markets being short here (1.0366)  is not for the fainthearted. But I would be looking to get short again while it is below 1.0640. Because in the longer run I am fairly sure that I think the Fed told us last night that we are going to have a low growth future for many years. This is not an environment that normally suits a strong AUD.

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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3 Comments on “Australian Dollar – Head Fake?”

  1. Steve Says:

    Even with all the market forces and bearing in mind mining is only 10% of Australian GDP and the ppi index the Australian dollar is verrrrrrrry over valued and is a bigger threat to Australia than global warming terrorism and cyclones put together

    Reply

Trackbacks/Pingbacks

  1. Equities and Australian Dollar Down again | Lighthouse Securities - August 11, 2011

    […] first on what the Fed was trying to achieve and then later after more reflection that I felt the Australian Dollars bounce was a head fake because the overriding story out of the Fed was that their is likely to be a low growth future. […]

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