What’s new in the land of OZ?

Australia is the world’s 13th largest economy, valued at around A$ 1.9 trillion (or equivalent of $1.3 trillion). However the country’s currency, the Australian dollar, is punching above its weight being the fifth most traded behind the US dollar, the euro, the Japanese yen and the British pound sterling. At the same time the Aussie dollar is the sixth most widely held currency, accounting for just shy of 2% of global foreign exchange reserves.

There are a few reasons why the Aussie dollar is in high demand relative to the size of its economy:

  • Strong rule of law, relatively stable political arena enjoying, by and large, a free exchange rate mechanism
  • In comparison to the US, the EU and Japan it had quite high interest rates especially during the last decade. It was the only developed economy which did not struggle during the recession of 10-12 years ago. As an example, interest rates in Australia were at around 5% in the aftermath, when in Europe and the US they were pretty much zero. Consequently, it benefited from extra demand brought on by the so-called carry trade – borrowing in low yielding currencies to buy into high yielding ones and pocket the difference (assuming relative stable exchange rate between the two categories)
  • Another solid support was brought on by its high correlation to commodity prices and exposure to the fast-growing Asian economies. Australia is a major producer and exporter of iron ore, copper, coal, gold, silver and uranium all in high demand at the turn of the century

Nonetheless, being linked to these commodities was also its weakest spot as that asset class is notoriously cyclical. After reaching a top in 2011 (see gold high of over $1900) commodities have been on a downtrend since, taking the Aussie dollar south with them. Interest rates have also been dropped in June and July 2019 and now reached a record low of 1%. Back then the AUDUSD was trading around 1.10 whereas now is just below 0.68. In addition, Australia is facing a bursting bubble in the property market coupled with sluggish household consumption. Talking about a downward spiral.

Recently, in line with the majority of central bankers around the world (soon to be all of them probably), the Reserve Bank of Australia has been looking to ease the monetary policy. So much so that the minutes of the last meeting on August 6th showed the RBA board discussing unconventional monetary policies including negative interest rates to spur growth and achieve its 2% to 3% inflation target. Markets are pricing in another rate cut to 0.75% by the end of the year and another one to 0.5% by February 2020.

The minutes showed ‘that a package of measures tended to be more effective than measures implemented in isolation’ according to board members and the US-China trade dispute increased the risk to global economic growth as business had already significantly cut back investment plans.

Bearish outlook
The AUDUSD has reached a top of 1.1080 in July 2011 which pretty much coincides with the peak of commodities cycle. Since then it has been in a secular bearish trend. A string of lower lows and lower highs clearly point to that with the market price now below the 9 and 21-week moving averages.

The downtrend was signalled initially by the 9-week moving averages (red line) crossing below the 21-week moving averages (blue line) seen in May 2013. However, since early 2015 until recently, we can see the AUDUSD trading sideways largely between 0.67 and 0.81.

But the downtrend resumed earlier this month with a drop below 0.67 to a low of 0.6676. An early signal was represented by 9-week moving averages again dropping below the 21-week moving averages and until that changes, ‘the trend is our friend’. Still, the bears will want confirmation and if this month brings a close below 0.67 they will be looking to run positions to next support around 0.6250 followed by the low of 0.6008 seen in October 2008.

Bullish outlook
If the downtrend is not confirmed and proves to be just a false breakout, the bulls will be looking for a rally back to 0.72 which is also a 23.6% Fibonacci retracement. Further resistance can be seen just above 0.73 as well as around 0.75 level.

This scenario will mean either a fortune reversal for the Aussie dollar (sudden healing of the housing issue and/or the slump in consumption) or the US dollar eventually weakens cheering President Trump. Although either scenario is possible, it looks to be a big ask in the short term unless the Fed starts to cut rates aggressively.