The Australian Dollar (FXA) is a currency highly sensitive to the global growth outlook, as Australia is one of the major producers of commodities. The AUD has been one of the most resilient currencies over the last few years, benefiting from high commodity prices and positive global GDP growth. However, this strength may be ending, due to the current global deleveraging process, the sluggish growth outlook in developed economies, and a possible end to the commodity boom if China's growth collapses.
Over the last two years, the AUD/USD has been trading in a relatively tight range. Currently, it stays above parity, but downside risks are mounting and the currency could start to decline over the next following months.
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Global growth is a key concern for risk currencies like the AUD. The IMF recently cut its global growth forecast for both 2012 and 2013 to 3.3% and 3.6%, respectively. The IMF's forecasts for Australian growth are 3.3% in 2012 and slightly lower in 2013, at 3%. This would have a negative impact on the AUD over the medium term.
As domestic growth slows, the Reserve Bank of Australia has started to cut its interest rates during this year. In early October, the central bank cut the interest rate by an additional 25 bps to 3.25%, justifying this move due to below-trend growth. This is also negative for the AUD, and with more cuts expected from the central bank in the near future, the Australian dollar should continue to suffer from erosion of rate support.
Furthermore, China is Australia's largest trading partner, and if growth weakens further in China, it will inevitably mean lower demand for Australia's exports. This would be negative for Australian growth and similarly, negative for its currency. Although a hard landing isn't yet supported by the data, the trend of slower growth is evident. While the AUD/USD managed to hold around parity over the last few months, going forward, the Chinese slowdown will continue to create negative pressure on the AUD.
In the short term, the AUD could maintain its resilience due to uncertainty regarding both the USD and the euro. In the U.S., the combination of QE3 and the possible fiscal cliff should be negative for the greenback, and in Europe, the ongoing sovereign debt crisis should continue to pressure the euro. These risks have made currencies like the AUD more appealing to investors, and should support it over the coming months.
Additionally, the recent data released dispelled concerns over China's slowdown -- at least in the short term -- given better than expected retail sales growth and a higher GDP quarterly growth rate. The Q3 GDP data came out exactly as expected, at 7.4% year-on-year, but there is some skepticism among economists regarding the accuracy of this data. However, these signs of bottoming out are certainly positive for the AUD in the short term.
Australia's close ties with China have helped the AUD strengthen over the past decade, but if Chinese growth continues to weaken and the RBA continues to cut rates, the AUD will be under huge pressure and could lose most of its current appeal.
In the short term, the outlook is hard to forecast, and the currency could be a two-way bet. Over the long term, however, the AUD seems poised to fall. Although the currency can be a popular buy on dips, more long-term oriented investors should reduce or even short the currency on periods of short-term strength.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.