Currencies | Sep 11 2014
-Fundamentals more important
-Decline in terms of trade
-Soft sentiment and economy
–Technical break
By Eva Brocklehurst
What has caused the Australian dollar to fall so sharply in recent days? The currency has broken out of the narrow range that was traded over the past five months. While fundamentals have been signalling such a move, ANZ analysts note the Aussie appeared stubbornly detached, trading above fair value, until now.
It seems the market became tired of pre-empting the US Federal Reserve's path in pulling back quantitative easing and was shy about leveraging the Aussie into the negative carry trade that the fundamentals implied. Carry trading involves borrowing in one country and reinvesting in another at a higher interest rate. What made traders sit up and take notice was a Fed paper, which showed a gap exists between the central bank's outlook and the market's view. This triggered a broader US dollar move, putting the Fed back in the centre of forex market considerations. The analysts note that several commentators, familiar with the Fed's actions, are suggesting that the policy bias may start to change at next week's Fed Open Market Committee meeting.
Although this speculation, triggered by the release of the paper, seemed to be the start of the break-down in the Australian unit, the analysts point out that it does not necessarily explain the Aussie's underperformance on all cross rates, including the AUD/NZD. Rather, the Fed paper looks to have been the last straw, as the case for the Aussie underperforming was already in place. This case is predicated on the consistent decline in both iron ore and coal prices, two commodities crucial to Australia's terms of trade, and key inputs to fair value for the currency.
The analysts maintain that the late phase of the mining boom – production – will have far smaller multipliers throughout the rest of the economy. Significantly because employment intensity is lower. Data out of China also signals that a de-leveraging trend is occurring and the extensive credit that supported investment will not be the driver of demand it once was. Moreover, the analysts observe Australia's Reserve Bank is likely to maintain a steady cash rate for some time and this expectation, underpinned by weak confidence data, means Australian interest rates are not such important determinants of the currency at present.
Technicals also play a part in the more bearish outlook for the Australian dollar. The break through US92.20c was an important catalyst on the downside, and the analysts suggest a weekly close below the 50-week moving average at around US91.80c will add more of a bearish tinge. ANZ analysts have a year-end target for the Australian dollar of US88c and suspect a new lower range is being forged.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
