Australian Business Confidence Soars Despite Warnings

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Today, the Aussie dollar is trading higher in part because National Australian Bank Business Confidence Survey showed a positive 3, the highest confidence number since August 2012, and the biggest one-month rebound in a decade. This is a large survey of over 500 businesses. The result in the forex market today is a rally from under 1.04 versus the USD to the current trade of 1.0460. This is down from the trade at the 1.0550 level late last week.

Not all observers agree with this unbridled optimism. Jessica Irvine, the National Economics editor, wrote: "Economists brace for a bump in the road." Continuing, she wrote:

"The Australian economy is hurtling towards a growth 'pothole' when the mining investment boom peaks later this year, a report warns." And by cutting spending, state and federal governments have made the hole even bigger, according to Deloitte Access Economics' quarterly Business Outlook, released today.

"Australia's economy needs a new growth engine," the Deloitte report says, warning that the "'Godzilla-like strength' of the Australian dollar is keeping a handbrake on recovery in non-mining parts of the economy, despite lower interest rates."

Later this week, Australian PM Gillard is expected to announce spending cuts because tax revenues have fallen short of projections. Remember, when the carbon tax and trade scheme passed, the government then embarked on various welfare spending plans for the anticipated revenue.

This is not the only cautious opinion about the Australian economy. A syndicated MarketWatch column from Sydney yesterday had this warning:

"As strong growth in the commodity sector no longer offsets weak domestic conditions, government finances -- both national and state -- are deteriorating. Federal government revenues have dwindled, with cash receipts running below expectations. This reflects a slowing economy, which has translated into lower-than-expected corporate tax revenues."

Another problem for Australia is, despite the mining boom, they have a negative trade balance. This will run about A$50B this year, or 3.7% of the GDP. With a slower economy, the deficit would go up to 5/6% per year, a high percentage for a developed country, which would need to be financed with foreign borrowing.

The manufacturing sector is handicapped by the expensive A$ and high labor costs. For example, U.S. minimum wages are about $8.00 per hour, or about half of the $16.00 per hour in Australia. Chinese and Mexican labor costs are even less. The Australian politicians have squandered an opportunity to use revenue from the mining boom to train workers, and help exporters compete in a competitive world where there is ample capacity.

Traders, as well as central banks have favored the Aussie dollar, and are long. If we look at the most recent COT report, we see the combined spec long position is 118K contracts. This is the largest spec long position in any currency. In a set-up like this, the market cannot deal well with negative news. On the 5th of February, the Reserve Bank of Australia will announce their bank rate. Currently at 3.25%, they are the highest in the developed world. We think there will be a reduction in the rate.

Considering the negative longer-term view of the Australian economy, we would like to trade this pair from the short side. There are some important reports coming from the U.S. this week. Should tomorrow's Federal Reserve announcement or the NFP on Friday prove bearish on the USD, we would like to sell the AUDUSD (NYSEARCA:FXA) in the 1.0520 to 1.0560 area.

The pair has been trading around the 1.05 handle since early December. Despite the heavy spec buying, the pair is still range bound, although some of the spec longs may be cross trading to a short yen. Use appropriate money preserving stops.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.