While the Australian dollar managed to post a 23-year high against the US dollar in the early days of November, the currency pair fell from 94 cents to 87 cents by the end of the year, erasing much of the early speculation that the Aussie will follow the Canadian dollar to parity with the US dollar.
Indeed, the more muted price action in the Australian dollar comes amidst gains in the US dollar along with cooling gold prices and less resilient outlooks for the Australian economy in 2008. Nevertheless, with the fallout from the subprime fiasco doing little damage to the Australian financial markets, the economy will likely fare better than its American and European counterparts and the prolonged boom in commodities should provide support the Aussie.
[B]The Australian Economy Remains Healthy, But Has Growth Peaked?[/B]
Ultra tight labor market conditions and strong consumer spending growth helped fuel expansion during the third quarter at a sturdy 4.3 percent pace of growth – the best rate since the second quarter of 2004. However, some cracks have started to appear in the Australian economy. In October, retail sales slowed for a second consecutive month to 0.2 percent from 0.7 percent, - not entirely surprising given the fact that oil prices climbed during that period. In November readings are not likely to be encouraging either, as consumers grappled with even higher oil prices while the Reserve Bank of Australia raised interest rates to an 11-year high of 6.75 percent.
Meanwhile, employment rose by a whopping 52,000 in November, which was more than double expectations for the figure. However, the unemployment rate actually rose to 4.5 percent from 4.3 percent. Why the divergence? With the labor markets continuing to improve and pushing wages higher, unemployed workers who were previously discouraged and stopped looking for work have come out of the woodwork to take advantage of the conditions. While businesses that deal with mining and commodities in general will likely to continue hiring, there are signs that companies are feeling a bit more cautious. Indeed, business confidence, as measured by National Australia Bank, has declined steadily throughout the second half of the year. Furthermore, capital spending plummeted 6.5 percent during the third quarter, marking the sharpest drop in nearly eight years, amidst concerns that the US will face recession and worries that Europe and Asia will see at least a slowdown in growth in 2008. As these fears come to fruition and demand for Australian exports starts to fade, employers may not be so keen to take on more workers. Clearly, this will not bode well for consumer spending, and when GDP releases for the fourth quarter of 2007 and the first quarter of 2008 start to hit the wires, the markets will likely see that economic growth in Australia has already peaked.
[B]
What Will the Reserve Bank of Australia Do?[/B]
Signs that expansion in Australia has peaked may be of some relief to the Reserve Bank of Australia, as the monetary policy board has long been worried that domestic demand would drive inflation through the roof. Indeed, core inflation surged the most in 16-years during the third quarter, propelling the central bank’s weighted-median CPI measure above their 3 percent tolerance level to 3.1 percent. This was the primary reason why the central bank raised interest rates by 25bp in November to an 11-year high of 6.75 percent, and with inflation anticipated to hold above 3 percent throughout the first half of 2008, they are still considered to be very hawkish. In fact, the minutes of the Reserve Bank’s December meeting revealed that, “absent the changes in market yields since the November meeting, there would have been a strong case on domestic grounds for a rise in the cash rate.” As a result, developments in the financial markets will be a key focus of the Australian bank, and if the national economy continues to face few headwinds from the credit crunch, traders will ramp up speculation for further monetary policy tightening. However, if economic growth has actually peaked and domestic demand cools further, the Reserve Bank of Australia may find that additional rate increases are not necessary, effectively removing much of the impetus for further gains in the Australian dollar.
[B]Keep an Eye on Gold[/B]
Aside from rampant inflation and rising interest rates, gold remains a major issue with respect to the Australian dollar. In fact, gold prices were probably a bigger driver of the Aussie over the past three months than economic fundamentals as the country benefits significantly from Chinese demand for the yellow metal. However, the peak gold settlement price of $835.20 on November 8 came just a day after the AUD/USD pair hit a 23-year high of 0.9399, and both gold and the Australian dollar have simply meandered lower since then. Nevertheless, gold and other commodity prices are anticipated to rocket higher once again in coming months, creating major upside risk for the Australian dollar.
Meanwhile it is important to mention that agricultural producers in Australia are struggling. Though inflation in this sector has been just as astronomical as many of its durable counterparts, output from Aussie firms has been lacking due to the worst draught in over 200 years. This has cut into many valuable categories that have contributed to growth in the past such as lost production in live stock (Australia is the largest beef exporter), wheat, wool and cotton. It has also undoubtedly restrained the growth potential for the Australian economy and the Australian dollar.
[B]A Risky Bet[/B]
Looking ahead, rising volatility and lingering doubts over the health of credit markets may prove to be yet another saboteur of Aussie strength. Financial markets have been extremely shaky since August, and this has raised doubts about the all-too-popular carry trade. In recent months, when credit market difficulties sent shock waves through global markets, the highly leveraged, overextended carry trade was quickly unwound to eliminate pent-up risk. All of a sudden, the passive collection on interest rate differentials was not appetizing enough to sustain multi-decade and record highs across the FX market. Evidence of this can be seen in early November, when a wave of risk aversion coincided with the AUD/USD drop from 23-year highs. As a result, traders should pay heed to the market’s tolerance for risk, as well as Australian economic data, commodity prices, and interest rate outlooks in coming months.
[B]Key Points[/B]
Heading into the beginning of 2008, Australian fundamentals are still relatively strong, and upside inflation risks have left the Reserve Bank of Australia maintaining a staunchly hawkish bias. However, export activity, consumer spending, and business investment are all suffering, posing grave risks to expansion in 2008. What’s more, the central bank’s November rate hike along with tighter global credit markets pose additional downside risks for the economy, as they threaten to cool lending to both businesses and consumers alike. If the air of uncertainty surrounding the world’s financial markets become worse, and inflation trends finally start to falter in Australia, the AUD/USD will quickly lose its luster. However, with demand for commodities like gold unlikely to decline any time soon and inflation pressures persisting, the risks for the Australian dollar during the early part of 2008 are skewed to the upside.
[B]AUD/USD Technical Outlook: Blow Off Top Expected[/B] – [I]By Jamie Saettele[/I]
We were looking for a rally towards .9500 last quarter. The AUDUSD did reach .9400 before undergoing a nearly 900 pip setback. However that setback is corrective and it is our contention that a significant low is in place at .8549. The entire rally from the 2001 low of .4775 is an A-B-C advance. Wave C has been underway since .6771 and is in its 5th and final wave now. Still, wave C would not equal wave A until .9998 (in pip terms). Again, this objective fits with the idea of a blow-off top and reversal.
