aud fundamentals

2007 Second Quarter FX Market Outlook

Tuesday, 10 April 2007 21:02:55 GMT  |  Daily FX Research Team

AUD/USD Outlook
In the first quarter of 2007 the Australian dollar has been the brightest star in the currency universe. The Australian economy benefited from a strong recovery in commodity prices and as a result, the Australian dollar rose to a decade high against both the U.S. dollar and the Japanese yen.

More specifically, the Aussie appreciated 17 percent against the US dollar from a March 2006 low of 0.7015 to a high of 0.8210 in just 12 months. The currency also gained from carry trade flows and was particularly strong against lower yielding currencies like the Japanese yen and the Swiss franc. It gained 15 percent against the Japanese yen, trading from a low of 82.07 on March 2006 to a high of 97.55 in April 2007 as yield hungry Japanese investors continued to buy the currency.. Currently, Australia's two year government bonds yield 5.48 percentage points more than similar Japanese bonds and have a 1.77 percent premium over U.S. Treasuries.

Can Australian economy continue to grow in 2007 with the benchmark interest rate set at 6.25%?
Since 1991, when the country had its last recession, the Australian economy has grown an average of 3.25 percent per year. Yet, after sixteen consecutive years of strong growth, many economists are concerned that in the expansion in the world’s 12th largest economy may have peaked. We can’t say we share the same opinion. The latest National Australia Bank Monthly Business Survey, Australia's most important survey of the non-farm sector, showed that business conditions and employment levels are close to cyclical highs. Unemployment has come down to a 30-year low and business confidence is recovering after falling last year when interest rates were pushed higher. Strong job growth has prompted consumers to spend more, and in February, retail sales rose twice as fast as expected. According to the Australian Bureau of Statistics, retail sales rose 0.9% in February to $18.8 billion, from $18.6 billion in January. Following the release of this key report the Aussie skyrocketed to a 10 year high against the US dollar on speculation the central bank would soon raise interest rates even higher. On April 3rd the Reserve Bank of Australia kept official interest rates unchanged at 6.25 percent, disappointing many traders and causing a sharp fall in the local currency, but the unit quickly recovered and went on to set new highs as expectations for an interest rate hike in May remain intact.

The RBA could be poised to increase the level of interest rate to a 10 year high
While the Federal Reserve kept rates on hold for the past 9 months, the Reserve Bank of Australia has been very active. The RBA increased the level of overnight rates three times in the last year pushing the price of money to 6.25 percent. Despite the fact that the cost of borrowing in Australia is one of  the highest amongst the world's most advanced economies, the RBA has been struggling to contain wage and price pressures. According to the TD Securities Melbourne Institute Monthly Inflation Gauge, the headline inflation rose 0.5 per cent in March contributing to an annualized rate of 3.5 percent, well above the 2 and 3 percent target range defined by the RBA. Unless price and wage pressures begin to ease the central bank could be poised to increase the level of interest rates to a 10 year high.

Australian benefited from a recover in commodity prices but the trade balance remained on deficit
The Australian economy benefited significantly from a recovery in global commodity prices. Gold is up 13 percent since the beginning of the year and the Nymex Coal futures are trading 4 percent higher than they did three months ago. Australia is both the world’s second largest exporter of gold and ranks fourth in the production of coal. The Australian economy continues to profit immensely from emergence of China and India as the two most heavily populated countries in the world account for nearly 17 percent of Australia’s total exports. In February, Australia's exports increased to 18.5 billion Australian dollars, a new historical high. Exports to China were up 26 percent while exports to India were up by 28 percent. On the other hand, Australia's has been reporting a trade deficit for more than four years and in February the country reported its 59th consecutive trade deficit. According to the Australian Bureau of Statistics, the trade deficit widened to A$838 million in February compared with A$832 million in January. The rise in the Aussie has been making lbusiness difficult for Australian exporters since their products become more expensive and as a result less competitive.

Conclusion
As we enter the second quarter of 2007 the Australian economy is operating at full speed and continues to exert inflationary pressure throughout the system. This steady rise in inflation could force the RBA to increase the benchmark interest rate in order to maintain both sustainable growth and price stability. In fact, rising wages, a low unemployment, strong consumer spending and a recovery on the housing sector have clearly boosted expectations for a rate increase. Looking at the interest rate term structure for deposits denominated in Australian dollars, one can see that expectations are clearly skewed for more rate hikes. While the 3 month Libor rate offers 6.5%, the 12 months offers 6.66%, a premium of 16bps. The additional monetary tightening could provide further support to the Aussie, particularly against the US dollar, since the Federal Reserve is widely expected to remain stationary for the time being. Higher interest rates should make the Australian dollar even more attractive to foreign investors as continued demand for carry trade could produce another rally in the Aussie against lower yielding currencies like the Japanese yen and the Swiss franc.

Technical AUD/USD Outlook
A 5 wave decline from the early 1970’s high (1.4900) to the 2001 low (.4995) is evident in the AUD/USD.  That means that this 5 wave rally from .4995 is likely the A wave in an A-B-C correction (extended 3rd wave and the 4th wave is a triangle).  We do expect a B wave decline to begin soon given that weekly RSI is overbought for the first time since November 2004.  Levels where a reversal could occur are at monthly pivot R1 (.8249) and R2 (.8410).  Still, a top is close at hand as the 5th wave is in 5 waves itself.  Coming under former resistance at the January high of .7979 would signal that a top is in place and that the Aussie was heading to test support at .7678 (March low).  The structure of the decline will clue us into the extent. A potential reversal point is the 1990 high at .8351.  A weekly close above .8400 would suggest that the rally is extending towards the 1989 high of .8915 (eventually).

 

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