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Australian Dollar to Fall as Sentiment Sours, Rates Outlook Fades

Australian Dollar to Fall as Sentiment Sours, Rates Outlook Fades

2011-07-30 01:03:00
Ilya Spivak, Head Strategist, APAC
Australian_Dollar_to_Fall_as_Sentiment_Sours_Rates_Outlook_Fades_body_Picture_5.png, Australian Dollar to Fall as Sentiment Sours, Rates Outlook Fades

Fundamental Forecast for Australian Dollar: Bearish

The Australian Dollar remains firmly anchored to underlying trends in broad-based investor confidence, with an average of the currency’s value against its leading counterparts continuing to show an intimate correlation with the MSCI World Stock Index. However, while global shares plunged the most in close to a year last week, the Aussie managed to produce a shallow advance. Looking ahead, the decoupling is likely to prove temporary, with the overwhelming headwinds battering risk appetite poised to sink the Australian currency as well.

The Aussie found support in an impressive second-quarter consumer priceindex reading that pinned the annual inflation rate at 3.6 percent, topping economists’ forecasts and marking the highest reading in 2.5 years. The outcome proved to be a boom for interest rate expectations, pushing the currency to new record high against its US namesake, but rosy bets on further tightening seem likely to prove short-lived.

Indeed, RBA Governor Glenn Stevens statement accompanying July’s rate decision explicitly said that while “inflation is likely to remain elevated in the near term due to the extreme weather events earlier in the year,” it is likely to return close to the target level as “temporary price shocks dissipate”. Clearly, this hintsa higher CPI reading was foreseen (at least in trend terms) by the central bank as it chose to leave borrowing costs unchanged for the seventh consecutive month, so taking the outcome to mean a hawkish turn is ahead seems decidedly overstated.

Meanwhile, the sentiment landscape remains fraught with danger. The US deficit-reduction impasse will take center stage over the weekend and into the opening bell, setting the tone for early price action. However, even assuming the best possible outcome (i.e. a mutually tolerable deal that also appeases the ratings agencies passes both houses of the US Congress and is signed by President Obama on or before August 2nd), traders still have ample reasons to sell as the pile of evidence pointing to a global economic slowdown in the second half of the year continues to grow while Euro Zone sovereign fears return to the spotlight.

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