- Expectations of Chinese stimulus are dampened while slower growth is more evident.
- Iron ore prices are on a downward trajectory with no bottom in sight.
- Australian economy has rebounded and extreme negative sentiment has been lifted.
- Recent Fed rhetoric is at its most dovish and further dovish rhetoric will be less effective marginally.
After years of naysayers predicting doom for the Australian Dollar (NYSEARCA:FXA), it appears the Australian Dollar is near a turning point, ironically right when things seem to be going smoothly. This article will attempt to present the case why now is the perfect time to go short the Australian Dollar.
1) Expectations of Chinese stimulus are dampened while slower growth is more evident
One of the reasons the market has been so slow to respond to much weaker Chinese economic performance (HSBC manufacturing PMI has been below 50 for over a quarter, credit growth is rapidly slowing down) in 2014 is the speculation over whether the Chinese would stimulate their economy on the scale seen in 2008. While pro-growth gestures have been made, the leadership has emphasized over and over again in the past few months that there will be no major stimulus programs. (See here and here.)
Going forward, I believe Chinese economic data will continue to surprise on the downside as an economy reliant on a credit boom is reined in. And this time, there's not much room left to speculate on major stimulus programs, which have neither come in the last few months, nor will come in the near future, as repeatedly stressed by policymakers.
This is directly reflected in iron ore prices, which have slumped to lows not seen since 2012. Given the importance of iron ore as an export, it's surprising this sharp fall in prices has not been reflected in the Australian dollar yet. Perhaps this was overlooked in light of other factors like speculation over Chinese stimulus policies or improvements in Aussie economic data. Personally I believe this will be a headwind going forward.
2) Australian economy has rebounded and extreme negative sentiment has been lifted.
Australian economic data has been mixed overall in the past two months, with employment data being the shining spot in the last two months. I'll agree with the RBA (Australia's central bank) that the transition from mining investment being a major growth driver (8% of GDP in its heyday to maybe 2% soon) to some other way of growing the economy will take time. Australian households are also highly leveraged so leveraging up is not a quick-fix answer either. The RBA also seems to be cautious about a potential housing bubble and very likely won't view it as a short-term solution.
This means that Australian economic growth probably won't pick up soon.
3) Recent Fed rhetoric is at its most dovish
After perhaps a mouthslip by Janet Yellen in March when stating that rates may rise 6 months after tapering is over, the Fed has understandably backtracked. The current rhetoric is unswerving dedication to tapering QE while raising rates some time in the hazy, distant future. Last week's testimony by Yellen was dovish as well with themes like the headline grabbing "highly accommodative policy needed for weak labor market"(paraphrased). Given that the Fed has been leaning towards hawkishness in its actions (remember when governors were talking about whether tapering was needed at all in the second half of 2013 and whether rates should even be hiked in 2016?), the current rhetoric is likely to be as dovish as it gets unless there's a major crisis.
4) Emerging market economies are starting to show strains
Strong action from emerging market central banks in January and a Fed that's somehow convinced markets of its commitment to an accommodative monetary policy despite consistent tapering of QE has soothed emerging market currencies in the past few months. However, emerging markets aren't just facing a short term crisis in confidence, many have argued (and I would tend to agree with their arguments) that emerging market growth in recent years has been tremendously boosted by credit booms. Now that capital is no longer flooding into EMs on the scale of 2008-2012, that cycle is going in reverse. Economic performance has weakened in key EMs like South Africa, which recently posted an April manufacturing PMI of 47.4, the fastest contraction since mid-2012. I would tend to believe whatever short reprieve EMs gained from hiking rates, currency intervention and a more dovish Fed will be lost once markets receive irrevocable proof that the credit boom in these economies are over and they are entering a contractionary phase.
To summarize, speculation over Chinese stimulus that hasn't been realized in months is starting to fade down. Any poor data in the future will likely be met with pessimism, instead of hope.
The Australian economy reported some good figures and the AUD rose 7% from the January low. Extreme bearish pressure has been taken off the AUD, yet its economy faces a lack of quick improvement options, while lower iron prices will pose a persistent negative shock.
The Fed's dovish rhetoric has likely reached its maximum and market participants have acted accordingly, with US 10-year yields falling to a 2014 low. Perhaps the Fed could get more dovish and yields could fall a bit more, but the pendulum has far more room to swing in the opposite direction. Emerging markets will also present negative shocks going forward.
For the reasons above, I believe it is an exceptionally fortuitous time to short the Australian Dollar and I'm taking a position personally (short AUD/USD at 0.9360). Of course, this is only a personal opinion and not an investment recommendation!
Disclosure: I am short AUD/USD. 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.