A long-term perspective is useful for us to place the recent bearish price action of the AUD/USD currency pair into context. To the chart below, I have added a sloping line (in black) to the pair's price action since the beginning of this century.
A break below the slope is quite pivotal: paving the way for a new trend, and a confirmation of the potential for the pair to hit at least equal lows with prices last seen during the global financial crisis. Using the month of October 2008, I highlight the closing price of that month (0.66602) and also the intra-monthly low of October 2008 (0.60060).
As shown also by my highlights (in green), areas below the October 2008 low exist which could trade over the medium term.
Clearly, further downside potential exists for AUD/USD. These levels have been traded before, and a market exists for the pair in this range of 0.66602 to 0.60060 should sentiment continue to shift the pair to the downside.
A major issue with the Australian dollar is Australia's exposure to commodities and international trade. Traditionally viewed as a "commodity currency", the Australian dollar usually rallies during the boom times of the business cycle. Yet more recently, while gold has rallied, oil has struggled. Meanwhile, trade war tensions between the U.S. and China have worsened, and the country's economic growth has slowed significantly.
Should Australia continue to suffer from a global slowdown in economic activity and concordant drops in commodity prices, the Reserve Bank of Australia may be forced to lower interest rates, especially if other central banks continue with expansionary monetary policy (however limited their ability is or creative they must become in order to do so).
The chart below maps AUD/USD price action on a daily candlestick chart against the yield differential between one-year Australian bonds and U.S. bonds. The spread provides us with a proxy for the short-term carry on this pair. Rises are bullish, while falls are bearish for this pair; the stronger the spread, the more attractive it is to hold the Australian dollar versus the U.S. dollar.
Unfortunately, the Australian dollar loses on two counts: not only is the spread negative at -0.93%, but it is also worsening. In effect, while Australian rates are positive at the time of writing, U.S. rates are stronger, hence the carry is negative. Given the headwinds Australia is facing, this trend is unlikely to reverse anytime soon.
Should downside persist, which I am inclined to believe it will, how far could the pair drop? In the chart below, I include the 0.66602 (previously identified and mentioned) in this article on the chart, and use weekly candlesticks in combination of volume profile analysis. Using volume profile analysis, we can identify levels that have been well-traded in the past and offer potential target areas for further liquidity.
Unfortunately, given the lack of price action in this area since 2008 (and before), the downside potential is quite extraordinary. To begin with, the pair has not yet hit the key level of 0.66602. I believe this will be hit in the near term. Then, retracements may occur in the broad region of 0.66602 (the October 2008 monthly close) and 0.71000 (the top of the "value area", which captures the series levels most well-traded in recent weeks and months).
Yet 0.71000 would be a stretch at this point, given the strength of the bearish price action in recent weeks. More likely, the levels of 0.68660 (the close of the week commencing May 13, 2019) and 0.69252 (the close of the following week which commenced May 20, 2019) will be met with heavy resistance. These levels of 0.68660 and 0.69252 are likely to provide AUD/USD with a ceiling for the foreseeable future, as the bearish trend continues to hold.
Those levels on the upside can be viewed on the chart above; note the bars on the right-side histogram, which indicate that they were traded with higher volumes. Price bounced in this region and ultimately descended. Further selling pressure can be expected if price revisits this area.
On the other hand, further downside from the current price of 0.67845 would pave the way not only for 0.66602, but also much lower, probably through to the 2008 lows that were set in the region of 0.60000 to 0.63000. This is because, while the headwinds that AUD/USD faces are not likely to disappear in the medium term, support levels are now extremely limited (or non-existent).
I would suggest the only way for the Australian dollar to soften its decline would be if the country were to outperform and release surprisingly positive economic data. Alternatively, if gold continues rally, and/or more importantly if oil prices were to strengthen, this pair may be able to recover somewhat. But rates expectations will ultimately continue to reign supreme, and any further negative trade war headlines are likely to hit the Australian dollar disproportionately.
In summary, I remain bearish on AUD/USD and trust that it will hit 0.66602 in the near term, before heading below 0.63000 over the medium-to-longer term (probably by the end of the first quarter of 2020).
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.