Australian Dollar weekly outlook – down eventually

November 7, 2011

FOREX

What’s your view on equities, the S&P 500 or the bourses of Europe? The reason I ask you this question is because if you can riddle me that then you know where the Australian Dollar is going to head in the next week or so.

 As the Prince showed earlier today over at MacroBusiness with his Chart of the Day  whether its commodities, or in this case the Australian Dollar, for many markets its just a bet a punt or a call on what you think the equity market is doing.

Take a look at this correlation chart from my Bloomberg terminal this morning, focusing on the third column in, and you see that over the past 3 months the Australian Dollar’s daily correlation with the S&P 500 (SPX) is 0.861, with the EUR it is 0.80 and with European Financial Stocks and the European Itraxx CDS index it is 0.79. It has a strong negative correlation with the CBOE Vix volatility index.

 

Clearly no surprises there but the key message is that the Australian Dollar is not trading on its own fundamentals, or if it is trading on its own fundamentals and perceptions of same, then everything is being influenced by Europe and the ebb and flow of sentiment about its impact on markets near term.

Indeed check out the chart below. What you see is the Major commodity currencies (AUD, CAD, NOK, BRL and NZD) daily since the beginning of October versus the CRB and the S&P 500. These have been indexed to 100 as at the 3rd of October this year and while you can see the correlation in terms of “levels” or percentage moves is not as strong as the directional correlation we outlined above it is clear that there is but one song in markets at the moment and it is the Siren Song. The only question is who is Odysseus – perhaps Nicholas Sarkozy given last week’s clearly traumatic events.

So what does it all mean?

It means that for all the 5 drivers and their importance for the Australian Dollar that it is really just Investor Sentiment, fear and courage, that is driving it at the moment.

But that does not mean the 5 drivers are irrelevant I think that they all are biasing the Aussie lower over the months ahead.

  1. Global Growth is looking weaker by the day – particulalry in Europe but as the RBA so eloquently highlighted with both its rate cut last week and its SoMP last Friday the risks are skewed to the downside. Heavily so I would argue.

Equally the weakness in our bulk commodities and the outlook for same flows from the reduced ebullience about the developed and developing world’s growth profile. This is also a negative for the Australian Dollar.

  1. Interest rate differentials – I personally think that Cash rates in Australia are going to 3.5% next year. Not quite as aggressive as the market is currently forecasting but substantially lower all the same from current levels. This will drag the 2 year yield down even further than it is at the present and further compress the spread to the US and other nations. Sure we’ll still be relatively high by developed world standards and so all support wont be kicked out but this is certainly a negative environment.
  2. The USD is moving up and down with risk as well – safe haven, no need for safe haven and so on. I doubt however that it will be as fundamentally weak as it was earlier this year because at least on a relative basis the US is outgrowing Europe and many other developed countries. So there will be residual support in that sense. This is not an overwhelming weight on the Australia but because I think it is all going to be about economics in the months ahead I would expect the USD to improve further as risk appetite goes off in some form.
  3. Technicals are currently rangebound. The Aussie is constrained in a 1.0750/65 – 1.0230/40 range with the bottom end of same giving support last weekly on a daily basis. I personally think that this support will break eventually but there is much would to chop and support below that as well.

As you can see in the chart below the Australian Dollar has not closed below the old uptrend support (1.0309 today) since it broke back up on October 24th. This to me would be the first signal of a deeper retracement but 1.0230/40 needs to give way on a daily close basis to really open up a move lower so I’m not going to get too bearish yet.

So summing up for mine i think the Australian dollar, like all other assets classes and indeed my sleep patterns are hostage to the European crisis. If you can tell me where this is headed then i can tell you where Aussie is going. But overall my bias is to sell rallies as they occur because I think the world is turning decidedly unfriendly for the Australian Dollar.

 www.twitter.com/gregorymckenna

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.

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. Australian Dollar technical outlook – Nearing important support | Lighthouse Securities - November 10, 2011

    […] for the worlds bellwether growth currency. It has sold down through the support i talked about earlier in the week and remains biased […]

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