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Where Is The Australian Dollar Likely To Go

Jul. 06, 2015 6:15 AM ETQBEIF, WFD, FXA
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Summary

  • Interest rate differentials between AUD and USD and how an expectations of interest rate hike in the US will cause investors to park their money in US dollars.
  • Consumer confidence signaling a decline in the housing permits.
  • Impact on commodity prices in reference to the Chinese economy.

From the beginning of the last year, AUD(FXA) has witnessed a decline of more than 20% and it seems that the Aussie hasn't seen the floor yet. This hypothesis is not just backed by technical analysis but fundamentals too explain that the current level of the dollar is not justified by the structural weakness in China or in Australia. This article will focus on a few aspects which will give readers some hint as to where the Australian dollar is likely to be headed in 2015 and then presents a few possible trading opportunities that can be taken.

Let's start discussing this matter in light of the current discount rate which needs to be further reduced in order to fully compensate for the downturn in the mining activity that has been impacted due to the reduction in Chinese consumption. According to the Press Release by the RBA back in May 2015, some of the problems that the economy could face were the subdued public spending, private spending is likely to head downwards especially in the non-mining sectors and reduction in business capital expenditure.

Source: Business Insider

Carry Trade

With that being said, the interest differential gaps between Fed Funds rate and Australian cash rate is narrowing which effectively means that carry trade which was popular sometime back would not be so popular going forward especially for investors looking for high yields on investment. As the unemployment rate drops to a seven year low in the US, the economists at Wells Fargo are expecting FED to lift interest rates as soon as in September. As we head into September the volatility for FX markets is going to surge and which is particularly viewed negative for currencies like AUD or NZD. Basically, all the smart-money will now be pulled out from the Australian dollar and parked in the US dollars to take advantage of the interest rate differentials

Source:Trading Economics

Consumer Confidence/ Housing Permits

We often hear the phrase that how quickly the markets tend to react when a piece of economic news release comes out and adjusts accordingly to it. But more than often it either over or under reacts but never fully prices in the effect.

Such is an example of the Australian building permits which we have been seeing is closely tracking the consumer confidence.

Source:Trading Economics

From the illustration, we can infer how well the consumer confidence tends to predict the Australian building permits. The consumer confidence for June declined by 6.9%. Retail sales and trade balance for June stood at 0% and -3.88 billion dollars.

For our forecasts, we expect to see a decline in the building permits for June. With that being said, the retail sales and trade balance have improved slightly but underperformed the consensus estimates.

Commodity Prices/ Exports

Perhaps, one of the main sources of income for Australia is derived from the commodities business. Now that iron ore, coal and other commodities have taken a plunge, this has drastically impacted the global trade for Australia. The RBA's index of commodity prices show that pain is yet to come. The RBA has placed over 50% of weight in bulk commodities such as Iron ore, Metallurgical coal and thermal coal. Australia's main trading partner China is now facing a lot of structural problems and doing everything to avoid a QE program which is why we have seen three rate cuts in this year only. With China now struggling to achieve 7% of growth per annum, Australia is now finding itself in abundance of Iron ore. The excess supply of iron ore has pressed down the prices because of which mining giants like BHP and Rio have stopped embarking on new projects and are waiting for a rebound.

However, the dynamics of China are not likely to change in the coming time which can be seen by the PMI figures that have constantly underperformed the analyst expectations. The NBS manufacturing PMI stood at 49.4 which basically signals contraction in the economy (FX Street). This coupled with the dramatic fall in the stock market in China has flagged concerns that the Chinese stock market could very well be in a bubble. These factors will cause the investor to take more cautious approach while investing in AUD.

Technical Analysis

From the above image, we can see that the market is trying to break the 75 level which the market previously rejected a couple of times. The MACD and RSI are both in a negative territory signaling a further decline. However, we have an opinion that the decline will stop around the 70 level after which we could expect a turnaround for this commodity currency. This sits perfectly with the 88.6% Fibonacci level as well.

So what could be done?

The investor should obviously remain cautious going forward especially considering we have a rate statement coming out next week. However, the investors should consider rebalancing their portfolio by adding a short position on Australian dollar or could invest in stocks which benefit from a depreciating currency. The stocks in particular that we think will outperform are Westfield Corp ( WFD) , and QBE Insurance( OTCPK:QBEIF). These two companies will typically benefit from translation effect and also their balance sheets are strong.

Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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