The Australian dollar has been one of the strongest currencies against the U.S. dollar since 2008 - and for good reasons. The Australian economy was stronger than the U.S., plus it was supplying all the commodities China could handle, and its housing market was stable.
There was a positive feedback loop between several major trends in Australia.
First, the Australia housing market got started later than it did in the U.S., so when the 2008 bubble collapsed housing in the U.S. and Europe, Australian housing markets continued to boom all the way through 2011.
Next, Australian interest rates were higher than in the U.S. and Europe. This sparked interest in what is known as a Carry Trade. A Carry Trade is where you buy assets with high interest rates (think AUD) and sell assets with low interest rates (think USD). Traders pocket the difference between these interest rates, and as long as the high interest rate asset continues to rally - or just doesn't go down - the trade can be extremely profitable.
Then, Australia is a gateway to Asian markets and supplies commodities to China. China has been on a tear for the last 40 years. Chinese demand for commodities has been growing and growing that entire time, and Australia was in a perfect place to take advantage of this growing demand.
There are more factors too, like Australia is an advanced economy with good legal structures in Asia, almost balanced budgets from the government, and good timing in terms of commodity price rallies.
These issues cannot be easily separated in our investigation of the strength of the AUD since the crisis. They fed upon each other, causing Australia to be a attractive home for capital.
But these factors are slowly turning negative for the Australian dollar - and the next year could be much tougher for Australia than the last several years. Please pardon the title of this post, but there are significant headwinds for the Australian dollar.
What were once reasons to buy the Australian dollar could easily become reasons to get out of the Australian dollar - and even sell it. The common ETF for the Australian dollar is the FXA.
Here are the top 5 reasons the Australian dollar is "doomed."
1. RBA on Rate Cutting Spree
Economic weakness in Australia forced the Reserve Bank of Australia (RBA) to cut rates aggressively at its last meeting. The carry trade - which has supported the AUDUSD and FXA for years - is far less compelling as Australian interest rates get lower. The "hot money" of the carry trade will find a new home, and it won't be Australia. This will tend to weigh down the AUD.
2. No Inflation in Australia
The RBA is given a green light to cut rates more because inflation in Australia is lower than expected, and seems to be falling. Inflation in Australia is 1.6% - so the RBA has room to be very aggressive in stimulating the economy.
3. Australian Housing Market Bubble Popping
Housing prices are actually falling in Australia - and this is a shock. Of course, they said "housing would never go down" and they were wrong. We all know how this ends - the same way it has ended up in Las Vegas, Florida, and Spain - in a string of rate cuts and then a banking panic. The capital which flooded into Australia and its real estate markets will pull out, forcing the AUD lower.
4. China Commodity Slowdown
China is actually cutting rates on its own to spur its own economy. China is slowing after years of concern about out of control growth and walking the inflation tightrope. Part of this is due to a massive overbuild in Chinese real estate, part of it is due to a slowing European economy, but the end result will be less demand for Australian commodities by China. Add in the massive stockpiles of commodities already in China, and you have a recipe for a weak 24 months of commodity demand. That's not good for Australia - or the Australian dollar.
5. U.S. Economic Strength
Yes, you read that correctly. I expect the last 6 months of 2012 to be good times for the United States.
Consumer spending has been higher than expected -and even better, upper income consumer spending has been very high. We've had better spending in the last 6 months then we've had in the last 6 years.
Then consider- we have rapidly falling gasoline prices. Gasoline will fall even farther over the next few months as oil continues its tumble due to speculation. Falling energy costs should add significantly to consumer spending.
Throw in additional stimulus from a scared Federal Reserve, and we have the conditions for a nice Obama Boom in late summer and fall in the U.S. - all while Australia is struggling.