Seeking Alpha
Long/short equity, medium-term horizon, hedge fund manager
Profile| Send Message|
( followers)  


(Click to enlarge)

Whither the Australian dollar? After a multi-month rally on improved China sentiment and a sharply declining U.S. dollar, the Aussie has been turned away at weekly resistance levels.

Fresh prospects for China growth slowdown, a mean reversion strengthening of the U.S. dollar, and continued problems within the Australian economy could all point to a continuation of a new long-term downtrend, visible on the Australian dollar (AUDUSD) monthly chart (below).


(Click to enlarge)

For Reserve Bank of Australia (RBA) governor Glenn Stevens, the only thing separating the Aussie dollar from a "materially lower" exchange rate is the Fed's enactment of "tapering" (a tightening of stimulus measures long since hinted at, but not yet enacted).

Given China's increasingly volatile (and questionable) demand for Australian iron ore and coal, and the RBA's willingness to take cash rates to all-time lows, "significantly lower" could mean the Aussie settling out at 2010 lows around 0.82, far below today's 0.95.

If you want a reason for the Aussie dollar's strength over the last five years, look no further than Chinese demand for Australian iron and coal. More so than any other country, Australia has been the big winner in China's booming demand for commodities.

Earlier this year, however, China's shift to what the IMF expects to be permanently lower growth rates finally weighed on Australian miners' profits and dragged the Aussie dollar lower, to the 0.90 area, after trading above parity with the U.S. dollar for the better part of the last two years.

Rumblings of renewed Chinese growth helped push the Aussie dollar back up to 0.98 this fall. But China's renewed demand for commodities has a great deal more to do with a rush to restock port inventories at low commodity prices than a true turnaround in industrial production.

As of this writing, dry bulk freight rates have been declining for nine days straight, as Chinese iron ore importers sit on cheap inventory they had rushed to buy during the last two months.


(Click to enlarge)

The RBA's response to Chinese slowdown has been textbook monetary easing. Governor Stevens has cut the RBA's cash rate to all-time lows of 2.5% in response to growing concerns. Low interest rates are sending already frothy housing prices in Sydney and Melbourne to even riskier levels, however, and the RBA has expressed reluctance to cut interest rates further.

Still, Governor Stevens has moved to talk the Aussie dollar down, saying in essence "surely the taper will come" - a reference to U.S. monetary policy - with the implication that the strong Aussie will find some relief in declining from "unusually high" levels once the greenback strengthens.


(Click to enlarge)

While the RBA is well aware it cannot fight the Fed any more than other financial players can, the Fed's effective decision to taper (when it comes) should mark the "beginning of a return to something resembling more normal conditions" according to Governor Stevens. A tapering Fed will likely make U.S. yields more competitive vs. Australian yields, weigh on commodity prices, and give the RBA more or less what it wants: a "materially lower" Aussie dollar, with trajectory potential into the low 80s.

As properly functioning markets act as forward discounting mechanisms, it is also possible the Aussie resumes its big picture downtrend well before any actual "tapering" occurs. The extent of concern over China's rebound - quite possibly more artificial than real - could further weigh on AUDUSD independent of Federal Reserve actions. Last but not least, economic fallout from an imploding Australian housing bubble, once it pops in earnest, could lead the RBA to get more aggressive in its easing stance.

A multi-month Australian dollar short was one of our strongest trades of the year thus far, as we caught the bulk of the move from $1.02 to the $0.90 level. We are now watching and waiting for potential fresh entry points as the big picture (monthly) Aussie trend looks set to continue.

Source: Australian Dollar Could Be Headed For Low 80s