The Australian Dollar Emerges A Big Winner From U.S. Fiscal Fiddling

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 |  Includes: FXA
by: Dr. Duru

The Reserve Bank of Australia (RBA) must be getting a bit antsy at this point.

After working hard to drive the Australian dollar (NYSEARCA:FXA) downward in an on-going effort to rebalance the Australian economy, the currency not only seems to have bottomed for the time-being, but it also appears now to be breaking important barriers against a spectrum of major currencies.

Perhaps the RBA assumed on-going U.S. fiddling with its fiscal issues would create the kind of forex volatility that would send the Australian dollar sinking lower. Perhaps the RBA hoped resolution of the fiscal fiddling would put bond tapering back on the market's radar and send the Aussie reeling once again. Instead, the market seems to find some element of "safety" combined with a decline in the dollar as expectations for tapering fade ever further into the future.

The RBA has remained remarkably inactive in currency debasement ever since the September statement on monetary policy notably left out wording giving the RBA scope for lowering interest rates. Adding to the intrigue, the market appeared to gain relief from the minutes of the October meeting given it contained no hints of pending action by the RBA to cool off the rising Australian dollar even while acknowledging softening conditions in the labor market.

From the minutes:

The Fed's decision at its September meeting led to a depreciation of the US dollar against the major currencies as well as against most other Asian and Latin American currencies, with the Indonesian rupiah a notable exception. The Australian dollar appreciated significantly against the US dollar on the day of the Fed decision and had appreciated further over the past month following the release of stronger-than-expected economic data, particularly for China. However, members noted that the Australian dollar was still around 10 per cent below its peak in April.

Current market pricing implied a very low likelihood of a near-term reduction in the cash rate.

With this quote the RBA seemed to take solace that the Aussie was at least still below its peak. This solace should certainly diminish with each additional uptick in the currency. AUD/USD is now only around 8% below its April peak. By printing market expectations without qualification or editorial from RBA members, the RBA implicitly endorses the low likelihood of further rate reductions anytime soon. The rate tracker continues to show a low likelihood (it mysteriously peaked in the immediate wake of the October policy statement):

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Graph on implied expectation of Change to Target Cash Rate for November 2013 Expiry Month

Source: ASX RBA Rate Tracker

The charts clearly show an Australian dollar than continues a strong rebound.

First and foremost is Friday's (October 18, 2013) breakout for AUD/USD above its 200-day moving average (DMA):

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Australian dollar breaks out

Against the yen, the Australian dollar is on the verge of making a second breakout which should essentially confirm the bottom in August…

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The Australian dollar is pressing on a major bullish breakout against the yen

The Australian dollar broke key levels against the euro and the pound as well earlier over the past month. While these are not quite as dramatic as the moves against the U.S. dollar and the Japanese yen, the patterns still look like tops in the currency pairs (EUR/AUD and GBP/AUD).

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GBP/AUD looks like it is topping

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EUR/AUD looks like it is topping

Source for charts: FreeStockCharts.com

While I seem to have successfully called the end of the Australian dollar's decline, the continued strength has caught me flat-footed. I casually expected 95 or 96 to hold on AUD/USD. More importantly, I have continued to expect the RBA, and governor Glenn Stevens in particular, to start jawboning against the Australian currency. Stevens had a chance during a Friday address to the Australian British Chamber of Commerce in Sydney. He covered the broad span of Australian history, compared and contrasted the Australian and UK economies and monetary policies, and discussed the need for regulation in the financial sector, but nothing on the current levels of the Australian dollar.

So now I find myself with the need to wind down a net short position against the Australian dollar and yet remain torn by disbelief that the Australian dollar has much more room to run. I think the fundamentals suggest the Australian dollar should be much lower but that matters little when market sentiment seems to be aligning firmly in the other direction. When/if I finally switch out the net short, I like most fading the euro and/or the yen versus the Aussie. If the U.S. dollar remains weak overall, AUD/USD could easily hit parity within the next two months or less.

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am net short the Australian dollar.