The Australian Dollar Is Set To Fall

by: Hedge Insider

The Australian dollar versus the United States dollar is set to fall further still, given a falling (and negative) short-term interest rate differential.

Further, while gold and oil have enjoyed recent upswings, it is possible that the demand for these commodities will start to peter out in the medium term.

Unless Australian rates can rise quickly in the near term, and/or unless gold and oil continue their strong resurgence, the Australian dollar looks to remain tepid.

This could signal a return to the long-term low of 0.62 in the AUD/USD pair, last seen in 2008 as the great recession took firm hold.

From a purely technical perspective, the Australian dollar (versus the United States dollar; AUD/USD) appears to be hunting a long-term low of around 0.62. This level was last seen towards the end of 2008, the year in which the Great Recession truly began to manifest. The weekly candlestick price chart below illustrates this level.

AUD/USD Weekly Candlestick Chart

(Chart created by the author using charting tools. The same applies to all further price charts presented herein.)

Long-term levels such as this, which appear to be "obvious", are of course not necessarily always reached. On the other hand, they do make good targets if trading sentiment is supportive of the direction. With the Australian dollar, sentiment does seem negative.

The chart below draws attention to recent price action since late 2015 moving into 2016, through to present day. (The candlesticks still represent weeks.)

AUD/USD Weekly Price Chart

After trading within a range from around 0.69000 to around 0.73700, AUD/USD broke to the upside as we moved into 2016. However, it was not until July 2017 that the currency pair was able to see levels around 0.80500. The pair surpassed this level several times, but ultimately failed to sustain its heights, and dropped aggressively through 2018.

A struggle to beat the 0.73712 level in December 2018 (which, as the price chart above notes, matches the top of the late-2015 trading range) then led into the flash crash seen in currency markets in the first trading week that ended in 2019. (The flash crash is visible on the right-hand side of the chart above, with the long weekly candlestick that has a comparatively small 'body'.)

Why is sentiment still negative? Because, despite changing sentiment with respect to U.S. rates, Australian rates are consistently falling. Below is a chart similar to the one above, except it includes the net yield on one-year Australian government bonds minus the rate offered by the market on one-year United States treasuries.

In effect, this provides us with a proxy for the short-term yield differential offered on AUD/USD: the stronger it is, the more attractive it is to sell (or, for example, borrow) U.S. dollars, and buy Australian dollars with the proceeds.

AUD/USD Yield Differential

Suddenly, it makes a lot of sense that the AUD/USD pair has fallen. In fact, it is surprising that it was even able to run up to the heights seen in 2016, 2017 and 2018. The short-term interest rate differential has continued to fall, and it is in fact negative (the chart shows -0.84% most recently). In other words, there is negative carry.

The actual carry will differ depending on the Forex broker used and how the trade is structured. However, because the carry on this pair is not strong in either direction (the differential is close to 0.00%), the Australian dollar does not look especially interesting from either side, from a carry perspective. (It does not look exciting to go short or go long.)

However, if anything, it looks like a short. The interest rate differential is not only negative as of present but also heading in the wrong direction. If you look to when 2008 drew to a close, when the Australian dollar saw its aforementioned long-term low of 0.62, the interest rate differential was actually 2% in favor of the Australian dollar (versus the United States dollar) as shown below.

AUD/USD Yield in 2008

Of course, with the Australian dollar considered a commodity currency, commodity prices are also very important to its price relative to other major currencies. Oil prices are especially important, as the price chart below indicates. (The chart maps US WTI oil prices versus the AUD/USD pair.)


The correlation between AUD/USD and oil prices is demonstrably strong. It appears that despite the Australian dollar appearing to target the long-term low of around 0.62, the recent run-up in oil prices (which I fortunately, and perhaps luckily, successfully predicted this time using Fibonacci) has prevented the currency from dropping too quickly.

Nevertheless, if oil prices are not stable to continue their run, and/or if the market continues to degrade Australian rates relative to U.S. rates, the pair is likely set to hit 0.62 over the medium term (perhaps later in 2019).

The chart below also illustrates the correlation with gold; another important commodity whose price, like that of oil, leads the Australian dollar up and down along with it.

AUD/USD vs. Oil and Gold

Without stronger rates, the Australian dollar needs the recent upswing in demand for commodities to persist. If gold and oil are unable to continue upward, this author believes (perhaps uncontroversially) that the Australian dollar will be set to hit 0.62 over the medium term.

One final chart to leave with, is slightly more creative. This averages the price of WTI oil prices with the gold price, and then indexes them. I have added four points of interest to the chart.

Oil and Gold Index vs. AUD/USD

Despite a bullish looking 2016 and 2018, this simple gold-and-oil index is now failing to establish those same heights seen in 2016 and 2018. For the Australian dollar, keep watching rates, oil and gold, among other things. And consider following me on Seeking Alpha if you found this article entertaining.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.