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Richard Cox, Market Bulls (59 clicks)
Macro, commodities, medium-term horizon, contrarian
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Recent sell-offs in the Aussie dollar, the AUD/USD forex pair, and the CurrencyShares Australian Dollar Trust (FXA) look extremely attractive to traders that rely on technical analysis strategies in their positions. So, for short-term traders looking for reversions to the mean, long positions might make sense. For investors focusing on the fundamentals, the medium-term future for the Australian dollar looks bleak, highly favoring those investors holding long positions in the U.S. dollar and the PowerShares DB US Dollar Index Bullish (UUP).

Specifically, the long-term view is being skewed by the Reserve Bank of Australia's (RBA) commonly touted inclination to start reducing interest rates in the second half of this year. This limits the incentive for investors to hold the Australian currency for extended periods of time. Currently, the RBA is holding its benchmark rate at 2.75%, which is an all-time low. At its last monetary policy meeting, no changes were made but the accompanying statements clearly showed the central bank is willing to continue easing monetary conditions with consumer inflation proceeding at a moderate pace and labor markets showing increased volatility. Any further reductions in interest rates from here will put cash rates in the Aussie below that of the New Zealand dollar, surprising given the currency's long history of holding the highest carry value among the majors.

In addition to this, external risks darken the forecast for the currency as well. China is Australia's biggest international trading partner and policy changes at the U.S. Federal Reserve show diverging paths for these central banks. In China, the latest market stories center on the unstable credit conditions present there, making it difficult for Chinese companies to obtain credit at cheap prices. The inevitable outcome here will be that these companies will be less able to generate production and manufacturing results at the same rates. This will also mean that these companies will see weakening demand for copper and other raw materials, typically purchased from Australia. In order for this to change, the People's Bank of China will need to convince markets that companies will be able to obtain credit easily, and at reasonable prices. Until this happens, the Aussie dollar will remain under pressure.

The last factor to consider is the changing policy stance in the U.S., where the Federal Reserve has shifted market sentiment by suggesting that quantitative easing stimulus could be reduced as early as September. The program as a whole could be eliminated by mid-2014, but this will require national unemployment rates to improve to 6.5%. We are still well above these levels, so it will be important to monitor Fed statements in the coming months in order to determine the relative strength we will see in the U.S. dollar. Reduced stimulus will mean a stronger U.S. dollar, and a weaker Aussie dollar, as diverging policies in these regions will favor the greenback.

Price Perspective

On the whole, the case against the Aussie dollar is three-fold. A continually dovish policy stance at the RBA, declining production and manufacturing prospects in China (pressuring Australian export markets), and the diverging policy changes likely to be announced by the Federal Reserve all remove the incentive to buy the Aussie dollar at current levels. From a price perspective, the AUD/USD currency pair is now seen breaking the 38.2% Fib retracement of the rally from 2008. This is a highly bearish event for the pair, as it suggests this rally has completed.

(click to enlarge)

For another angle, we can look at the AUD/JPY, which is also breaking through some very important long-term levels. From the chart below, we can see prices grinding through the 50% Fib retracement of the rally from the middle of 2012. A monthly close below this level targets a further drop into the mid-80s.

(click to enlarge)

Source: Sell Aussie Dollar On Broken Fundamentals