The Australian dollar was once again one of the top performing currencies in the first quarter of 2008, as high domestic interest rates and surging global commodity prices boosted demand for the currency. Indeed, the Aussie reversed previously sizeable declines—setting a significant base at $0.8511 before rallying nearly 1000 points to multi-decade highs of $0.9502. Relative US dollar weakness has meant that the AUD/USD exchange rate remains near its highest since 1984, but the Australian dollar has clearly fallen relative to other major currencies as well. Recent Aussie weakness is most pronounced against the Japanese Yen, which has fallen nearly 12 percent in a mere matter of months. Given an increasingly unclear fundamental outlook for the Australian dollar, it may simply be a matter of time before we see similar AUD weakness against other forex counterparts. Such an outlook will almost certainly depend on several important and interrelated factors: the stability of global commodity prices, the state of the global carry trade, and whether or not the Australian economy can survive a pronounced US economic slowdown.
Global economic growth has clearly slowed through the first quarter of 2008, but continued strength in commodity prices has nonetheless boosted demand for Australian production. Such a trend has likewise shown its effects on the Australian dollar; the Aussie holds the second-strongest correlation to the benchmark CRB Commodities Index among all G10 currencies. As such, strong gains in commodity prices have had similar effects in the high-yielding currency. Of course, such strong linkages to raw materials prices are a mixed blessing. Noteworthy declines in gold and other precious metals have recently led to similarly sharp moves in the AUD. The net result is that outlook for the Australian Dollar will be very much linked to the outcome for commodity markets through the coming quarter; can gold and other prices continue their astronomical ascent, or will a slowdown in economic growth limit upside in prices?
[B]Global Growth: Recoupling? Decoupling? Can Commodity Prices Continue at Astronomical Levels?[/B]
Whether or not commodity prices—and, by extension, the AUD—can continue to rise will largely depend on the future of global economic growth. A rapid pace of expansion across the globe has resulted in a similar gain in demand for commodities. Outlook for prices will subsequently depend on overall developments in the global economy. We have already seen the US economy undergo a significant slowdown through the final quarter of 2007 and we will likely see further weakness through 2008. For many, the question becomes whether the contraction in US growth will result in a commensurate slowdown in other global economies. A cursory look at the long-term relationship between US and Asia-Pacific economic expansion rates shows that there is a strong link between growth rates in the US, Australia, and New Zealand. Despite the shallow US economic recession in 2001, Australian and New Zealand expansion rates still fell in tandem with that of the American economic giant. As such, many feel that ongoing stress in US markets and plainly evident deterioration in growth rates could easily lead to similar moves in Australia and New Zealand. According to official economic data, however, economic activity in Australia remains very clearly robust and shows few signs of slowing.
The growth in the Australian labor market is already beginning to slow and it may just be a matter of time before consumer spending follows suit. Business and consumer confidence surveys also show that enterprises and consumers fear an economic slowdown in the coming months. Given such robust signs of domestic growth, it is perhaps counterintuitive to believe that both producers and end-users have grown pessimistic in their outlook for growth. Yet such bearish expectations are linked with the fact that interest rates and the general cost of borrowing have increased substantially. Given further Reserve Bank of Australia interest rate hikes and a tightening of global credit markets, domestic industry is feeling the pinch from increased costs to credit. These considerations are clearly important in determining outlook for Australian growth and, by extension, the underlying fundamentals for the domestic currency. Perhaps more importantly, however, the relative level of Australian interest rates has recently shown a more direct impact on the AUD’s performance against major forex counterparts.
[B]Reserve Bank of Australia Most Likely to Keep Rates Unchanged, Remove Key Pillar of Aussie Dollar Support[/B]
The Australian dollar has unquestionably benefited from a steadily rising interest rate differential against almost all G10 counterparts, but a recently neutral outlook for the future of official Reserve Bank of Australia policy rate may limit the currency’s yield-linked demand. Recent comments from RBA Governor Glenn Stevens suggest that interest rates may have peaked in the current monetary policy tightening cycle. Governor Stevens has said that the cumulative effect of rate hikes and financial market duress have made for “substantial” tightening of monetary conditions in the Australian economy. Many subsequently claim that the next RBA rate move will in fact be a cut—a bearish proposition for any interest rate-sensitive currency. Market yields show that traders largely agree with pessimistic economist forecasts; the spread between benchmark 3-month rates and their 2-year counterparts is at its most negative in several years. Given such a sharply inverted medium term interest rate curve, it is arguably only a matter of time before speculators unwind interest rate-linked Aussie positioning. Yet it will likewise be important to watch interest rate developments for other major currencies. If other major currencies see rates stay flat or fall through the same period, the AUD may nonetheless continue to enjoy a fairly substantial yield advantage and see strong carry trade support.
[B]What to look for in the Australian Dollar in the Second Quarter, 2008[/B]
Outlook for the Australian dollar will depend on several key factors: commodity prices, interest rates, and the health of the domestic economy. Significant deterioration in commodity prices or the domestic economy will easily be enough to crimp demand for the domestic currency, while an ongoing correction in interest rate forecasts has already begun to hurt the AUD against select counterparts. Given that the Aussie has rallied on such strongly growing interest rate differentials, a subsequent moderation and potential contraction in rate spreads could certainly change underlying fundamentals for the high-yielder. Yet relatively few central banks are expected to leave rates stable through 2008, and this may in fact keep the AUD’s yield-linked demand intact. Such an outcome would be Australian dollar-bullish, but there nonetheless remain several key factors that may dent demand for the Asia-Pacific currency.
[B][U]AUD/USD Technical Outlook[/U][/B]<u></em>
The entire rally from the 2001 low of .4775 is an A-B-C advance. Wave C has been underway since .6771 and is either completing its 5th and final wave now or has already completed it at .9496. It would take a decline below .8512 in order to confirm that a top is in place at .9496. As long as the AUDUSD is above .8512, it remains possible that the rally from .8512 is an ending diagonal that will not be complete until closer to 1.00. Wave C (from .6771) would equal wave A at .9998 (in pip terms). What is important to understand is that the AUDUSD has either topped or is undergoing a topping process this quarter that will lead to much lower prices later in 2008.
