Fundamentals Not Supportive of Australian Dollar Despite Current Price

Ongoing tensions in the Middle East, and soaring commodities prices (oil above $100 and gold to fresh record highs by $1440) seem to be taking a backseat as market participants have been shrugging of fears and once again buying into riskier and higher yielding currencies. Any recovery in the Greenback seen on Tuesday was all but wiped away on Wednesday, with higher producer prices out of the Eurozone helping to reaffirm hawkish expectations from market participants for today’s European Central Bank rate decision. Language out from various ECB officials over the past few weeks has certainly tilted more to the hawkish side, and many now expect the ECB to begin to signal a move towards higher rates. The key today will be whether the central bank shifts away from describing current rates as “appropriate” and moves to a language which calls for the “normalization” of rates. On the other hand, if the ECB cites a significant risk to growth from higher oil prices, we could see a major paring back of Euro long positions. As of now, the market is pricing in a hike in the policy rate to 1.25% in August and then a second hike in either November or December.

The broad based negative sentiment towards the US Dollar has intensified in recent trade and even the higher yielding and risky currencies like the Australian Dollar have managed to benefit. We remain highly skeptical of the strength in the antipodean, with data continuing to show signs of slowing and China also producing weaker than expected results. This in conjunction with a potential oil crisis stemming from geopolitical threats is certainly not supportive of a higher Aussie. Most recently, Aussie building approvals were an absolute disaster, while China non-manufacturing PMI dropped to a 2-year low. In our opinion any Aussie supportive price action from a slightly better than expected Aussie trade balance should have been more than negatively offset by the disappointing building approval and China results.

Nevertheless, the US Dollar remains under pressure as global diversification away from the Greenback remains a central theme in the FX markets. While the Euro contemplates a move back above 1.4000, the Franc sits just off record highs, and the Yen is not too far away from its historic highs either. Meanwhile, the Australian and Canadian Dollars trade just off post float record highs and multi-month highs respectively. This is all a testament to the extreme commitment on behalf of the markets to move away from US Dollars irrespective of other market themes, with both risk and safe-haven currencies showing a positive correlation to one another relative to the buck.

Right or wrong, we continue to hold a net bullish US Dollar outlook as we contend that there are still some major problems that both Europe and Asia will need to contend with over the coming months. Ultimately, we see this translating into a narrowing of yield differentials back in favor of the Dollar, when the Fed does begin to signal a reversal in monetary policy. While other central banks are prematurely contemplating a rise in rates (we say this because we feel that they will not allow enough time for their economies to recover before raising rates), the Fed is waiting for the right time to begin to tighten so that when it does finally tighten, the economy will be able to handle the monetary policy shift.

Looking ahead, the calendar in European trade is rather full, with a batch of PMIs from Europe and the UK due out, along with some Eurozone retail sales. However, the markets will most likely wait to make any serious moves until after the ECB rate decision and subsequent 13:30GMT Trichet press conference. US equity futures and gold prices are tracking marginally lower into the European open, while oil remains bid above $100.

EUROPEAN ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD:We said a daily close above 1.3860 would be required to officially open the door to the next upside extension through psychological barriers by 1.4000 and towards key medium-term resistance from November 2010 at 1.4280, and the market made things difficult by closing just at 1.3860 on Wednesday. While this sends a strong message that we could in fact now see this next major upside extension, we will defer our bullish opinion another day to see where we close on Thursday. A close above 1.3860 on Thursday will solidify bullish prospects, while back below 1.3860 will alleviate topside pressures and open the door for some significant downside. Ultimately, a break and close back below 1.3700 will be required to officially shift the structure.

USD/JPY: Although the market has come under some intense pressure in recent trade back below 82.00, overall price action remains largely consolidative and we would expect to see the market once again well supported in the 81.00’s. For now, 81.00 remains the key level to watch below, and only a close below this figure would negate the current range-bound price action and give reason for concern. As such, we like the idea of buying on dips into the 81.00’s in favor of a bullish reversal and close back above 82.00.

GBP/USD: After failing to establish above 1.6300 over the past several weeks, the market finally managed to break and close above the level on Wednesday to suggest that a fresh upside extension towards 1.6500 and beyond is now underway. Look for a break back above 1.6350 to accelerate gains, while a drop back below 1.6215 would now be required to alleviate topside pressures.

USD/CHF: The latest break to fresh record lows by 0.9200 is certainly concerning and threatens our longer-term recovery outlook. Still, we do not see setbacks extending much further and continue to favor the formation of some form of a material base over the coming weeks in favor of an eventual break back above parity. From here, big figures become key support as we are in unchartered territory, while a break back and close back above 0.9320 would be required to relieve immediate downside pressures.

Written by Joel Kruger, Technical Currency Strategist

If you wish to receive Joel’s reports in a more timely fashion, email jskruger@dailyfx.com and you will be added to the distribution list.

If you wish to discuss this or any other topic feel free to visit our Forum Page.