Currencies | Oct 20 2011
– Aussie dollar's recent bounce appears unsustainable
– Rate cut, iron ore price or ongoing economic growth concerns could spark weakness
– Correction could also address apparent over-valuation of currency
– Dollar likely to remain subdued against greenback through 2012
By Chris Shaw
While the Australian dollar weakened late last month as concerns over emerging market growth saw a cutting back of net long positions, hopes the global recovery remains on track have seen a bounce in recent weeks.
The bounce was significant, Brown Brothers Harriman noting the Australian dollar was among the top performers in the G10 from late last month. The strength reflected increasing optimism over the situation in Europe and better economic data out of the US, as well as hopes China can avoid a hard economic landing.
CIBC World Markets suggests solid domestic data has also lent support to the Australian dollar this month, as September jobs ads were stronger and August building approval numbers also rose.
But the view of CIBC is any rally in the Australian dollar against the greenback should be short-lived, as a rate cut by the Reserve Bank of Australia (RBA) is looking increasingly likely before the end of the year.
As well, the strong commodity price outlook that has supported the Australian dollar for some time is now facing a serious test, this due largely to a deceleration in the rate of growth of the Chinese economy.
When added to downbeat PMI indicators, there appears little to support the Australian dollar in CIBC's view, especially when the OECD suggests the currency is overvalued by as much as 30% at present. In CIBC's view this leaves the dollar at risk of a sharp, shorter-term correction towards 0.97 against the US dollar.
Brown Brothers Harriman agrees, seeing immediate downside risk for the Aussie given still elevated uncertainty and extended short-term positioning. This has left the currency looking over-extended against the US dollar.
As evidence of this, Brown Brothers Harriman notes the spot rate of the Australian dollar is currently nearly 4% above its 20-day moving average, a level nearly double that of any other G10 currency.
If global risk appetite continues to decline the Australian dollar is likely to fall, Brown Brothers Harriman suggesting the 20-day moving average level of 0.988 against the US dollar is likely to be the next level of support in any decline.
Recent declines in iron ore prices are a further risk for the Australian dollar in the view of Commonwealth Bank (CBA). Iron ore accounts for 27% of Australian merchandise exports and the bank notes the price has fallen by 17% since early in September.
While CBA has not yet adjusted estimates for the currency to reflect the iron ore price, reports Chinese steel mills want to negotiate for lower contract prices mean an eye must be kept on the Australian dollar in the current environment.
Beyond the shorter-term, CIBC expects the Australian dollar will remain subdued against the US dollar given a restrained global growth outlook through 2012. What could offer some support for the Australian dollar according to Brown Brothers Harriman is the 100-basis points in interest rate cuts priced in for the next 12 months appears too aggressive.
While the RBA has turned more dovish with its commentary, Brown Brothers Harriman suggests any policy action is conditional upon a sharp deterioration in the global backdrop. In contrast to the market, the group expects the RBA will remain on hold in coming months.
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