Australian Dollar Weekly Market Wrap

See the latest Australian dollar analysis here:

Macro Afternoon

Another strong week for the bulls in the AUD with an overnight high of 1.0978 and a close just a few ticks lower. It was a week where a combination of factors contributed to the Aussie’s strength with the USD weakness we highlighted last week and then again in my post Thursday.


So it was that the AUD and the CHF (Swiss Franc) made new modern day highs against the US Dollar. Even the EUR,  troubles in the periphery and the looming Greek debt haircut and all, is back up near 1.50, where it has no right to be.

The key here is that currency traders are always focussed on relative bets and at the moment the driver of these relative bets is not just an overall weak US economy (otherwise how could EUR and GBP be strong) but the outlook for interest rates. In Australia, Switzerland, Europe and elsewhere, central banks are signalling a continued bias to tighten, while in the US Ben Bernanke’s discussions during the week left us in no doubt that althoug QE2 is ending, it is nowhere near ready to reverse course. Indeed the GDP data released this week for the US just highlights to ongoning parlous nature of US Economic growth.

So the AUD rallies.

But its just not USD weakness that is driving the AUD, although it is probably the dominant driver at the moment. The AUD is also stronger against the EUR reflecting the fact that all other things equal traders and investors still see Australia a decent destination for their investment dollars.

Granted, the AUD looks overcooked and the USD looks oversold short term technical indicators, but the drivers of Aussie strength remain undiminished.

Let’s recap:

Interest Rates – Higher than expected CPI gets the RBA back in the frame and although rises are still priced as some months off by the market this highlights that through time the Aussie’s yield pick up will remain large. We’ll see what Governor Steven’s says this week after the Board meeting.

Commodities/Global Growth – Commodities are still rising on the back of USD weakness and still supporting Aussie in a scary positive reinforcement loop. Anything that threatens commodities will threaten the Aussie but not at present. On the growth front the markets continue to ignore global headwinds preferring to focus on the here and now.

Investor Sentiment – This benign environment of relatively lax Fed policy and still positive economic growth oultook (don’t think too hard, some of these drivers appear either incongruent or irreconcilable – that is the mistake of people who lose money in FX) is keeping equities bid and overall risk appetite buoyant. Although I’d note this Aussie strength feels like a crowded traded and word on the street is that “real money” investors are starting to baulk at buying at these levels.

Technicals – Overbought in the short term but Fibonacci projections (my single favourite indicator) suggest the 1.12 region. A pullback would find good support initially around the 1.06 level. I’ll do a proper technical snapshot on Monday.

USD – No need to flog this horse again, the Fed’s own measure of the US TWI is at the post Bretton Woods low. Even the Mexican Peso is rallying against the USD. In terms of DXY (USD Index – which is heavy Europe) we are a few percent away from 20 year low and these two facts help explain why Tim Geithner said that the US still believes in a strong dollar. Theoretically true but practically on the back burner for a while. On this front the CNY (Chinese Yuan) is at its strongest against the USD since 1993.

So support for the Aussie from an investment fundmanetals point of view remains strong and even though it feels overbought support will come back on any non-China related selloff at lower levels.

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  1. Commodities are still rising on the back of USD weakness and still supporting Aussie in a scary positive reinforcement loop.

    More crazy than scary. How China keeps growing at 10% p.a. without inflation and with a currency pegged to the USD I don’t know. Eventually something has to break.

    • Sceptic Sandgroper

      China has massive inflation, ignore the “adjusted” inflation stats from government. Wage demands are running at 20-30%, fruit and vegetable prices are soaring, the Government has been forced to raise its fuel prices and there are spot breakouts of strikes and protests like the truck drivers near the Shanghai port last week. There is no fairy tale ending here, a hard landing is most likely, the only issue for investors is timing. My prediction mirror points to late 2011 or 2012.

  2. The flight from USD-denominated financial assets (as distinct from commodities) is really starting to take on a life of its own. Perhaps we are still in the early days of this cycle. Who knows. One thing is obvious. No-one really wants to buy US assets. And why would they?

    Several seemingly incompatible things have to happen in the US in order for its currency to win back lost supporters:

    US Government finances have to be fixed, and fixed relatively quickly. The citizens and corporations of the US have to begin to properly tax themselves, control public spending and get their budgets into the black.

    The absurd deadlock that passes for politics in the US seems certain to prevent this essential fiscal re-balancing. It is good enough for the Greeks, the British the Irish, the Spanish and the Portuguese. It was good enough for the Mexicans, the Russians, the Argentinians and the Brazilians in the past. It is good enough for Americans too. The days of American exceptionalism are over, at least in monetary matters.

    Americans should ask themselves why any-one would lend them any more money when they clearly have neither the intention nor capacity to repay it; when they prefer to leave their debts to their children instead.

    US monetary authorities have to start to pay a positive rate of interest on official debts. This did not matter so much when inflation seemed to have evaporated. But inflationary pressure is back, and the US is now importing it.

    The trouble is, the monetary authorities also have to help the US economy to find its mojo again.

    In both fiscal and monetary terms, stimulating the economy and protecting the value of the currency have now become opposing goals. Policy contradiction is institutionally embedded in the US these days.

    The result is the USD is becoming a one-way bet: SELL.

      • DXY @ 71?

        Never sell on an historic high; never buy on an historic low.

        It is foolhardy to bet against the US…..yet the US monetary and fiscal authorities keep giving the markets reasons to do just that. Short-term US debt generates negative real returns, so there is almost no reason at all to hold these securities. They generate instant losses.

        It is equally difficult to justify holding long-term official debt because excess supply, serviceability and ultimate real redemption value are all negative risk factors. The only virtue of this market at the moment is its liquidity.

        The flight from USD-denominated financial assets is the market’s way of responding to the opportunity cost of holding such assets. The markets are saying these costs are greater than the likely gains. Until this equation reverses, the price of these assets will fall. This will happen as holdings of existing assets are liquidated and as (truly vast) supplies of new assets are offered to a glutted market.

        You may be right about 71. But at the end of the day, this is just an arbitrary number on an index. It does not mean much in itself. What is meaningful is the proposition that borrowers have to offer an acceptable return to lenders if they are going to attract funds. At the moment (and for the foreseeable future) the US is neither willing nor able to offer positive returns to lenders. The result is the migration of cash from USD-assets into every other conceivable asset class.

        Perhaps this is the real next bubble: not just one bubble, but an entire bubble bath….

        • Deus Forex Machina

          I’m dong a blog about technical levels for tomorrow but RT is right…from a technical perspective. We need to watch these levels if someone is trading.

          Longer term if it bounces of there a couple of times then it becomes solid support for the moment, its a watch level.

          Cheers DFM

  3. You think I’m exaggerating?

    Imagine what would happen if the dominant reserve currency becomes an asset class that no-one wants to hold.

    There is nothing immutable about the negotiability of US debt. It is just an asset like any other, meaning value is fixed by the interaction of supply and demand. Because the overnight price of official debt is fixed arbitrarily by the Fed, and not by the market, at the margin the market is using other liquid proxies to re-price the US dollar.

    This diversification/ substitution can continue indefinitely in a system with completely mobile capital. It is driving the phenomena we are now observing in currency and commodity markets.

  4. Crikey asked some of our top economists for their take.

    Paul Bloxham, chief economist for Australia and New Zealand HSBC: I don’t think there’s very much you can say that will talk down the dollar. The Aussie dollar is a very well traded currency and the market is liquid enough that talking it down doesn’t have an effect on its level. The main thing that will determine it will be the rhetoric from the RBA tomorrow in regards to interest rates [if they say they won’t rise them]. First, let me point out that I don’t expect them to do that. The RBA will be thinking the strong currency is helping them contain inflation, and I suspect the RBA won’t be trying to talk down the dollar. The major impact will be what they say they will do about rates. We expect it will be more hawkish. The markets are suggesting the RBA will be looking to lift rates and that is likely to see more capital flow towards Australia and put upward pressure on the exchange rate.

    I think central banks can have an influence on their currency in that way [in talking down the value of their currency]. But Australia has a free floating exchange rate, so we don’t have a tendency to do this. We have a very highly traded currency and so moves by the RBA, even if they were considering trying to stem the extent to which the dollar appreciates, the market flows would overrule them. Most of the Asians economies have managed floats and they manage the flows and their exchange rates. But we don’t have that system. If the RBA attempted to do it, it wouldn’t be particularly successful and I think they know that.

    Tom Elliott, managing director of MM&E Capital Limited: It’s a difficult one. Best thing to do is to say that interest rates aren’t going up, but the RBA can’t do that as the last inflation data was quite strong. Ben Bernanke announced in the US last week that they wouldn’t touch interest rates for a long time. The RBA can’t possibly say that. They could say “we think it’s overvalued”.

    The other thing they can do is open market operations, where they sell AU dollars and buy US dollars. When the foreign exchange market bombed out, the RBA sold foreign currencies and bought Australian dollars. It’s not easy to talk a currency down without talking about the currency. But engaging in open market operations, that would probably knock a few cents off it. The RBA has been pretty good in the past and they’ve made a lot of money by intervening. In the US, they’re a “Don’t fight the Fed” mentality, but the market doesn’t think that way about the Reserve Bank. It’s hard to say whether they should or shouldn’t. It’s not good for the economy, but it’s helping keeping a lid on inflation. But if they came out and said we’re not putting up interest rates for a year, the politicians would love it, the public would love it and the Aussie dollar would go down, but they’re not going to do that.

    Bill Evans, chief economist at Westpac: I think that whether the RBA wants to intervene or not depends on whether their data says the acceleration has been sharp. What we’ve seen is it up 5 cents in a couple of weeks, that’s borderline. But sharp movements to the downside worry them a lot more, so I would be very surprised if they were intervening in the current situation.

    They have the power to adjust the other policy settings, given what we saw last week, which signalled the potential for rate hikes. [They could] use tomorrow’s statement to say they are in no hurry to moderate rates, but I don’t think they will. I think they’ll be careful for people to realise they have taken a jump inflation seriously, but they’re not ready to move rates.

    On the occasions they have intervened and it’s become known to the market, it’s had quite an impact. You don’t want to be buying when the RBA is selling. Their supply reserves are fairly limited, not like Japan or the Fed, instead the RBA’s level of reserves are roughly $20-30 billion. So people are aware that there’s limited intervention available.

    The policy is that they never target a level, but they do get interested if they’ve seen a strong move in either direction. The move so far is line ball and unlikely to lead to any action and partly because as inflation fighters, the rising currency is more helpful to them then when it’s falling.

    Associate Professor Steve Keen, University of Western Sydney: Even though the currency looks fabulous, there are lots of reason to expect it to turn around at some point, and the people who are extrapolating a permanent rise in the currency are kidding themselves. Anything that rises this quickly is a bubble. It’s speculative, it will burst and when it bursts you’ll see a far faster fall because the carry trade will be in reverse. You’re welcome to gamble on it, it’s a gamble where you win little and lose big.

    The RBA has been very lax in letting the dollar rise as much as it its has, interest rates have helped that. They have been paying too little attention to it. They’re ignorant of the Dutch disease. Our tourism industry and education industry are being screwed by the high dollar, but the damage has been done. You can’t just reverse it.

    It should be talked down. The reserve bank does this by pointing out that the currency is overvalued and warns of the dangers of having a speculative hold of the dollar. Put people who do speculative buys into a fear. [This government is busy] discouraging people smugglers, we’ve been encouraging dollar smugglers and we need to scare them off. If there was a cut in interest rates, that would cruel the currency trade.