AUDEUR – a new paradigm?

January 13, 2012

FOREX

The Australian Dollar Euro exchange rate has been  making another new high this week so its time to talk about whats going on.

Last week I posed the question of whether Australia was the new Switzerland. It was a question that I didn’t mean literally but metaphorically. That is, is Australia now the place people see as a safe receptacle for investment funds.

Now while I didn’t mean and still don’t that the Australian Dollar or Australia is a safe haven per se there is enough evidence in the buying of Australian Bonds and on the Australian Dollar crosses that something is afoot. A couple of years ago the Aussie broke out against sterling, the British Pound, it’s above parity against the USD and has recently broken out strongly against the Euro as you can see in the chart below.

 

Indeed in this Bloomberg chart you can see that for 15 years the AUD/EUR rate traded in a broad but fairly stable range prior to the GFC. This was particularly the case between 2000 and 2007.  Then the GFC came along, the AUD/USD collapsed and with it the AUD/EUR rate but since then the AUD/EUR has been strong against the USD and as such has also risen against the EUR.

Now currencies are bilateral exchange rates so many different things on both side of the cross can move them. In this case you can see, I think, that it is the AUD side of the AUD/EUR cross that has been the big driver of the moves between 2007 and 2010 before 2011’s more range trading mode when the USD was going up and down with perceptions of risk and thus the AUD and EUR were doing the same.

 

I’ve always thought of the AUD/EUR as a bit of a risk bellwether. Indeed when I was NAB doing the Currency Strategy thing full-time my offsider, Michael Jansen, built us an index of global risk aversion which we then put into our AUD/USD valuation model. The unintended consequence of this was that it was a pretty good indicator for the AUD/EUR and AUD/CHF cross rates.

Below is a stylised chart show the movements in AUD/USD, EUR/USD on the top panel and AUD/EUR and S&P 500 ( as a global risk bellwether) on the bottom panel.

 

What you can see here in the bottom panel is that the AUD/EUR was an almost perfect beneficiary of the bounce from the pessimistic crescendo back in March 2009 and then the QE induced risk rally. But equally what you see from time to time and particularly recently in the green box on the right of this chart is that it is Euro weakness that is now driving the break higher in the AUD/EUR cross.

So where to from here?

On a purely technical basis this cross is on tenuous ground up here at 0.81 on the basis of my MACD indicators as you can see in the chart below. But having said that I do see this as a decisive break higher and would see any move back toward the top of the old trend channel at 0.7750 and multiple Fibonacci resistance at 0.7770/0.7820 as likely to hold. So technically my best guess would be I’ll get a chance to buy this better at some stage and I would like to do it closer to this support zone because I’ll know quickly if I am wrong.

Fundamentally though you have to wonder  how the EUR/USD rate is still staying so high given all the challenges the Eurozone faces particularly the German data we overnights he other night. If Germany is going backwards then heaven help the rest of the Eurozone.

 

Indeed with USD/DEM (USD in terms of German Deutschemarks – interpolated by Bloomberg) at a still very low level there is plenty of room for USD to strengthen and the Euro to fall further. Personally I like Euro back toward the lows of the last few years at 1.18 against the USD.

So longer term if the Euro weakens because of European economic weakness and recurrent sovereign debt issues require it without a severe dislocation to markets AUD/EUR is going substantially higher. Dont forget EUr weakness wont hurt the US too much as only around 13% of the USD economy is made up of exports. Indeed a bit of ECB QE might weaken the Euro later this year but also put upward pressure on risk appetite and risk assets. That will be manna from heaven for the AUD/EUR exchange rate.

Of course if Europe causes markets to go into a funk then it is likely that the AUD/USD will get hit but Euro will probably fall further and faster than the AUD, so supporting AUD/EUR.

So I guess by the end of this piece I’m still bullish AUD/EUR although I don’t want to buy it on current levels. We’ll get a chance to buy a pullback first I think. But don”t think I’m revelling in AUD/EUR up here – it’s just another cross rate hitting new highs and thus pressurIng Australia’s export competing industries.

Ultimately this probably sows the seeds of the Aussie’s demise against a host of currencies as it undermines the economic growth profile for the Australian economy going forward. But that’s for another time.

NB: this post was written and queued Thursday night January 12th before the successful European bond auctions and the rally in the Euro. This just reinforces my view that the AUD/EUR was topping and is ripe for a pullback.

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.

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