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AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

2011-10-06 17:33:00
Joel Kruger, Technical Strategist, David Rodriguez, Quantitative Strategist, and Ilya Spivak, Currency Strategist,
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Monthly Chart

Australian_Dollar_US_Dollar_Exchange_Rate_Forecast_body_EUR10.png, AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

Prepared by Joel Kruger

The market is finally confirming the formation of a major top by post float record highs set back in the summer at 1.1080, with the latest break back below parity confirming our bearish outlook and opening the door for more significant declines going forward. From here we look for any rallies to be well capped below parity on a weekly close basis, with a break below 0.9000 to accelerate declines and expose 0.8500 further down.

Australian Dollar / US Dollar Interest Rate Forecast

Currency, Central Bank

Australian Dollar,Reserve Bank of Australia

US Dollar, US Federal Reserve

Net AUDUSD Spread

Signal

1-Year Expectations(Basis Points)

(154)

10

(164)

Bearish

Yield in 1 Year(Percent)

3.21

0.35

2.86

Bullish

Australian_Dollar_US_Dollar_Exchange_Rate_Forecast_body_Picture_6.png, AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

Australian Dollar / US Dollar Interest Rate Trading Bias: Bearish

A substantial breakdown in Reserve Bank of Australia interest rate forecasts have forced Australian Dollar weakness, and indeed calls for rate cuts may continue to hurt the AUDUSD in the year ahead. The Australian Dollar has been a primary beneficiary of high yields as traders sought to buy it against lower-yielding counterparts. Yet such interest rate-linked demand is fading as spreads compress, and indeed we think the AUDUSD may have set a significant top based on such trends.

The more important shorter-term driver of AUDUSD price action nonetheless remains the Dow Jones Industrial Average and broader risk sentiment. Indeed, the correlation between the AUDUSD and the Dow trades at record strength. Expect the Australian Dollar to continue to track moves in broader financial market risk sentiment. Any further signs of aggressive RBA rate cuts could likewise produce AUD weakness.

Australian Dollar / US Dollar Valuation Forecast

AUDUSD Valuation Forecast: Bearish

Australian_Dollar_US_Dollar_Exchange_Rate_Forecast_body_Picture_7.png, AUDUSD: Australian Dollar US Dollar Exchange Rate Forecast

Source: Bloomberg

While the Australian Dollar has reclaimed its place as the most overvalued currency against its US namesake despite recent weakness, with spot trading 28.4 percent above its PPP-implied exchange rate. The supportive powers of a robust RBA rate hike outlook have faded, with the central bank now priced in to issue close to 150bps in rate cuts over the coming year. Risk appetite trends have also turned against the Aussie as the lingering EU debt crisis and a rapidly deteriorating outlook for the global economic recovery weighs on the sentiment-sensitive currency. A meaningful correction appears finally to be underway, with traders still left with a hefty 2700-pip value gap to be exploited.

What is Purchasing Power Parity?

One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.

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