The Australian dollar rose at a furious pace in the first half of the third quarter as inflation remained well above the central bank’s 3 percent target, pushing traders to bet on increasing interest rates in August.
AUD/USD Outlook
The Australian dollar rose at a furious pace in the first half of the third quarter as inflation remained well above the central bank’s 3 percent target, pushing traders to bet on increasing interest rates in August. The interest rate hike was delivered, but the Australian dollar did not have enough momentum to extend its rally above 77 cents as gold and base metal prices began to tumble and economic data took a turn for the worse. The currency pair peaked out against the dollar in early September and closed the quarter below 75 cents, which was just a few points lower than where it started in July. However as we begin the fourth quarter, things are looking up for the Australian dollar as economic improves. Australia’s brand new Central Bank Governor, Glenn Stevens has also reiterated his predecessor’s hawkish tone, signaling the risk of another rate rise.
Another Rate Hike Contingent on Q3 Inflation
With two 25 basis point interest rate hikes under their belt this year and a new Governor in tow, the Reserve Bank of Australia, now headed by Glenn Stevens, face the task of deciding if they should raise interest rates for a third time in 2006 to bring the benchmark rate to 6.25 percent. The primary drivers of the previous rate hikes this year were inflationary pressures and economic growth. These will be the same drivers in the months ahead, with the primary emphasis on price pressures. In the second quarter, inflation grew at a very strong rate of 4.0 percent, well above the Reserve Bank of Australia’s target of 2 – 3 percent. Oil prices played a large role in boosting global inflation, and in Australia, it was no exception. Yet oil prices have retreated quite a bit in the third quarter, which should help to ease Q3 CPI. The question is by how much. Oil prices did not begin to fall until late August and remained stubbornly high (above $70) for the first two months of the quarter, which could keep Q3 numbers elevated. It may not be until the fourth quarter that we see a larger retracement in consumer prices. In terms of growth, the housing market remains very strong with lending reports for the sector holding near record levels. The labor market also remains very tight with jobs increasing by 31k in the month of September. This was six times larger than the market’s predictions and marked the strongest 6 month job growth in over a year. It also pushed the employment participation rate to 65.1%, a record high and dropped the unemployment rate to 4.8%, a 30 year low. The healthy labor market should help to increase spending, which could boost GDP figures after the disappointing read in the second quarter. The August trade balance report already suggests that we could see a strong third quarter after the deficit shrank to the second lowest level in four years. In order to get another rate hike out of the RBA however, Stevens would need to see economic data reflect an up tick in retail sales as well as still prevalent inflationary pressures.
What to Expect from Glenn Stevens
Former Governor Ian Macfarlane, who retired on September 18th, has subsequently been replaced by his former Deputy Governor, Glenn Stevens, to serve a seven-year term. Mr. Stevens started with the Reserve Bank of Australia in 1980, when he worked in the research department and was a visiting scholar to the Federal Reserve Bank of San Francisco in the US in 1990. Starting in 1992, Mr. Stevens held various positions within the RBA until he was designated as Deputy Governor in December 2001. After working closely with Mr. Macfarlane for nearly five years, Mr. Stevens is likely to govern in a similar manner by keeping a tight grip on inflation and resisting political pressure over monetary policy, which is expected to be a key issue in the run-up to next year’s federal elections as Australians start to worry that higher rates will push up their mortgages. In his first speech as Governor, Mr. Stevens indicated that there was some confusion about the state of the Australia when he said, “Is the economy growing below trend and putting downward pressure on inflation or is it still strong and putting upward pressure? The varying bits of data leave you uncertain.” However, he also commented, “Over the next little while, the main job is to ensure that the inflationary pressure we have been experiencing of late is successfully resisted, and that expectations of future inflation remain well anchored…The price data to be released over the next couple of weeks will be important in evaluating the outlook and the balance of risks facing policy.” Clearly, the Q3 CPI reading due out at the end of October will make or break the decision of whether or not to tighten monetary policy before year end. Given the Governor’s recent hawkish statements, he certainly will not want to appear soft on inflation, thus indications of steady or increasing price pressures in the Australian economy could lead to a benchmark rate of 6.25% by 2007.
Gold Correlation Will Continue to Impact Aussie
In addition to where interest rates are headed, commodity prices will also have an impact on the future direction of the Australian dollar. After reaching a 26-year high of $730.40 an ounce in May, gold has fallen nearly 22 percent to trade at $570 an ounce. As geopolitical tensions rise with North Korea, prices of the safe haven asset are beginning to bottom out. If this continues, this could help the Aussie register more gains. However, if prices do not budge far from current levels and they fall victim to further selling in commodities, the Aussie could suffer as a result.
Expansion in China Goes Relatively Unfettered
China will continue to provide long term support for Australia’s economy. The August trade data indicated that exports to China increased 22 percent from the same period a year ago in the two months ending in August. China’s expansion is continuing to intensify with growth expectations by the People’s Bank of China increased from 10 percent to 10.5 percent for 2006. In the second quarter, annualized GDP growth surged to 11.3 percent, a 12 year high. Third quarter annualized growth is anticipated to slow to 10.3 percent, but will nevertheless keep GDP on track to meet central bank estimates. Despite efforts at taming growth via hikes of the benchmark rate in April and August to its current 6.12 percent and the gradual increasing of flexibility of the Yuan, albeit marginally, China has followed one double digit quarter with another. Given the amount of steam in the economy, unless the Chinese government takes drastic measures, such as allowing the national currency to be more freely traded, growth is not likely to slow by much. With this rate of growth expected to continue, raw material fuel will be needed in order to move forward. As in the previous quarter, Australia, the world’s third largest minerals owner by value of production is likely to be the preferred source for the necessary imports due to its proximity to China. The increase in exports will fuel the sector throughout the year and keep the already tight labor market in high demand.
Conclusion
Given the current factors, the key to further Aussie strength will be where interest rates are headed. The Australian dollar faces more upward pressure than downward pressure at the moment as the economy improves and gold prices bottom. RBA Governor Glenn Stevens will be closely watching the price data that is due out in the coming weeks. Traders should as well. Strong inflation numbers will support the call for another hike before the end of the year while softer figures will push that expectation out to 2007.
Technical Outlook
The symmetrical triangle that began on 2/20/2004 remains intact. Triangles are often 5 (a-b-c-d-e) waves and this triangle has completed 4 waves. The current wave would be the fifth and thus the favored view is that AUD/USD is heading towards the supporting trendline from the triangle near the .7100 figure. A break below the triangle would expose the confluence of the 38.2% of .4775-.8003 / 6/18 low at .6770/72. Of course, a rally to the upper end of the triangle and subsequent break of the resisting trendline near .7700 would negate the scenario mentioned above. Weekly studies are bearish with RSI below 50, negative MACD slope and price recently closing below the 40 week SMA (closed below on the week that ended 9/29). The recent rally in AUDUSD is nearing the resisting side of a former 6 month supporting trendline (broke on 9/27). The confluence of that line and the 61.8% fibo of .7721-.7413 at .7603 is potential resistance.
AUD/USD Weekly Chart (Source: FXTrek Intellicharts)
AUD/USD Positioning
Long Australian Dollar positions topped out on 9/5. The AUDUSD topped out that week as well at .7721. Traders were long 49,751 contracts that week, just a shade below the record of 58,973 contracts which was set the week that ended 3/25/2005 (AUDUSD topped out that week and declined over 200 pips). Declining long interest following extreme long interest denotes deteriorating sentiment