It is probably only a matter of time before the next deep swoon in the Australian dollar (NYSEARCA:FXA).
On August 7th (Australian time), the Australian Bureau of Statistics (ABS) reported a spike higher in Australia's employment rate from 6.0% in June to 6.4% in July. This changes what looked like stabilization to an ominous 12-year high in Australia's unemployment rate. Prior to July's reading, the unemployment rate had hovered between 5.8 and 6.0% since August 2013. Accordingly, the odds of a rate cut in the September Reserve Bank of Australia meeting jumped from 4 to 9%. These are still small odds but enough to generate a large drop in the Australian dollar as the odds surely increased much higher for a rate cut later in the year.
Odds of a rate cut jump higher…
Source: ASX Rate Tracker
…the Australian dollar hits a two-month low against the U.S. dollar, apparently confirming the recent topping action
The one caveat to this report is that the unemployment report was mainly driven higher by a large influx of entrants into the labor force. Depending on the demographics of these new entrants - were they mainly young people entering the workforce for the first time (potentially employable?) or formerly unemployed adults who are making another attempt to get back to work (harder to employ?) - the unemployment rate could shift sharply again in the coming few months as the new workers get absorbed. Note that in July the Australian economy ADDED 14,500 full-time employed workers that was offset by a 14,800 drop in part-time workers. The next few months will be critical, as it is hard to imagine the RBA sitting still on interest rates if the unemployment rate starts trending higher, especially with the Australian dollar staying extremely over-valued by the Bank's account.
Commodity prices are also working against the premium valuation of the Australian dollar. The report on July's index of commodity prices confirmed what plunging iron ore prices are already telling us: the decline from 2011′s peak has accelerated. With the index back to levels last seen in March 2010 in SDRs, the RBA should feel quite comfortable cutting rates again soon (SDRs, or special drawing rights, are an IMF monetary unit indexed to major currencies).
So now both the unemployment rate and commodity prices should be working against the lofty levels of the Australian dollar. Given the presumed pressure, I decided to juxtapose the unemployment rate with the commodity index. With commodities playing a major role in the Australian economy, I expected to see a correlation with the unemployment rate. The relationship is quite striking in the past 10 years or so.
Australian Unemployment Rate Versus Commodity Price Index (SDR)
The Australian dollar is likely key to breaking the correlation. As the RBA stated in its last decision on monetary policy (and many before that): "The exchange rate remains high by historical standards, particularly given the declines in key commodity prices, and hence is offering less assistance than it might in achieving balanced growth in the economy."
The time for more (RATE) action must be nearer than ever.
Be careful out there!
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: In forex, I am net short the Australian dollar.