Australian dollar may be ready for a turn-around

Summary

The Australian dollar has been one of the weakest of the major currencies this year, down 9.07 percent versus the USD and 6.8 percent on a trade-weighted basis.

AUD decline can be attributed to several factors

1. UNATTRACTIVE INTEREST RATES: USD short- and long-term interest rates crossed higher than comparable AUD rates early this year. Historically, AUD rates are always higher, helping make it the perennial favorite G10 currency for parking excess cash… until now.
2. POLITICAL INSTABILITY: On August 24, Australia’s Prime Minister Turnbull was ousted after his support collapsed within his center-right Liberal Party. He was replaced by former national treasurer (and more business-friendly) Scott Morrison. Not one prime minister has completed a three-year term since 2007, so expect an election sooner rather than later.
3. KEY TRADING PARTNER CHINA: Australia’s trade with China dwarfs trade with all other countries. China’s decelerating economy and trade war with the US do not bode well for Australia’s economy. The weakening Chinese yuan since June has put pressure on the AUD, since these currencies typically move in the same direction.
4. SOFT COMMODITY PRICES: Prices of metals important to Australia, iron ore, nickel, copper, and gold have been declining since mid-May.

There are some compelling reasons to be supportive of the AUD

1. STRONG ECONOMY: Australia is benefiting from strong economic growth and record jobs creation. The country has not suffered a recession in almost three decades. The weaker AUD is certainly providing a boost for Aussie exporters.
2. SPECULATORS POSITIONED EXCESSIVELY SHORT AUD: According to CFTC reports, currency speculators, as a group, have the largest net short AUD position since late 2015. I consider this an overcrowded position, which means it should be difficult for AUD to be pushed much lower from here without a correction first.

Technical analysis

The AUDUSD downtrend is intact as it approaches 2½ year lows, just under $0.70. However, the charts provide a few signals that may suggest a pause or even a reversal of that downtrend. First, the AUDUSD is technically oversold on short-term charts (not shown); second, $0.70 has served as a key turning point (yellow ovals) several times over the last 15 years; and lastly, $0.70 is considered by traders as a key psychological level (as it’s considered a major round number).

Final remarks

Summer is over, and FX traders around the world are back at their desks. Trading activity in the financial markets typically increases in September as traders build positions for the final push of the year. Often this renewed activity will either continue or reverse existing trends in a substantial way.

The fundamental and technical factors that have been driving the AUD lower are still relevant and intact, but there are signs that the end may be nigh.

For those firms effectively short AUD (those with expenses down under), it may make sense to take some chips off the table (it’s been a good run), and reduce exposure.

For those firms long the AUD, it may be better to hold tight and wait to see if that $0.70 support level holds. If it breaks with conviction, technical traders see $0.65 as the next target.

Next steps

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Read our FX Risk Advisory article FX Forward Strategies for Volatile Emerging Markets.

Source: Bloomberg 2018.