aud fundamentals

Australian Dollar May Break High If Risk Appetite Holds Up

Saturday, 07 February 2009 04:29:01 GMT  |  John Kicklighter, Currency Strategist

The Australian currency posted the biggest rally against its safe-have US counterpart this past week; but the this may ultimately be a fragile fundamental driver to be dependent on for strength over the week and beyond. Gauging the general sentiment behind the markets; there is a certain sense that the rebound in risk-related assets (like the Australian or kiwi dollars, yen crosses, equities, etc) is more a pull back in fear than a genuine rebound in optimism.

Australian Dollar May Break High If Risk Appetite Holds Up

Fundamental Outlook for Australian Dollar: Bearish

- The Reserve Bank of Australia cuts its benchmark lending rate another 100 basis points to 3.25 percent
- A rebound in risk appetite helps carry the high-yielding Australian dollar higher

The Australian currency posted the biggest rally against its safe-have US counterpart this past week; but the this may ultimately be a fragile fundamental driver to be dependent on for strength over the week and beyond. Gauging the general sentiment behind the markets; there is a certain sense that the rebound in risk-related assets (like the Australian or kiwi dollars, yen crosses, equities, etc) is more a pull back in fear than a genuine rebound in optimism. This may seem the same thing, but there is a clear distinction. Easing fear does not necessarily put investors on the hunt for yields, it simply means that they are not scrambling for the assets in otherwise circumspect positions. In contrast, a true rebound in risk appetite leads capital to high yields – which the Australian economy currently enjoys.

Gauging the future of market-wide sentiment is a highly speculative proposition. Global growth has faltered (the IMF expects a pace that hasn’t been seen since WWII); the financial system is still suffering from a persistent lack of liquidity and absence of lender confidence; and a trend in global interest rates towards zero have essentially wiped out the incentive for taking on risk so soon after a severe collapse in capital market just a few months ago. Some of the notable events that could help spur a positive outlook next week are the Bank of England’s plans to start buying commercial debt; the potential for either the UK and/or US setting up a ‘bad bank’ to absorb toxic assets from Bank’s balance sheets; and most prominently the expected approval of a massive US financial stimulus package. As we have seen time and again in the past, just one or two of these initiatives will not be able to carry optimism on its own. However, with the cumulative effort adding up, a confluence of these policy efforts may be able to turn sentiment around.

Turning our focus away from these vague events, we will also have a significant amount of Aussie data for immediate volatility and perhaps some lasting guidance on long-term growth forecasts. Without doubt, the top event risk for the entire week is Wednesday’s employment data. Not only is this indicator a known volatility generator, it is holding greater and greater significance over the future of the economy as consumer spending is now seen as the key to growth going forward. Forecasts for yet another month of job losses and a rise in the unemployment rate are certainly not shocking; but a negative surprise could certainly undermine bullish sentiment developed from other sources. Other consumer related indicators are the Westpac’s confidence gauge and the inflation forecast report. Both of these, as well as the business confidence survey due Monday, could be fodder for a dovish hold on RBA policy going forward. - JK

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