Forecast Alert! Australian dollar could rally 4-6% on short-covering move

By Gary Howes

The Australian dollar (AUD) is forecasted to stage a strong rally as markets readjust to the new reality laid out by the RBA.

The pound sterling, US dollar, euro and the rest of the G9 could be in for a shock when it comes to the Australian dollar; a readjustment in sentiment towards the AUD is currently underway.

The pound to Australian dollar exchange rate is trading 1.63 pct lower, the Australian dollar to US dollar rate is 1.71 pct lower and the euro Aus dollar exchange rate is 1.75 pct lower.

(Note: Our AUD quotes are taken from the wholesale spot markets. Your bank will charge a spread at their discretion when passing on a retail rate. However, an independent FX provider is so well placed on the market that they are able to deliver you up to 5% more currency. Please learn more here).

The forecast, according to analyst Kathy Lien at BK Asset Management, is for an extension of these moves in the region of 4-6%.

Lien tells us:

"After selling off for the past 3 months with virtually no relief rallies, we believe that the Australian dollar has officially bottomed.  For the first time in 2 years, the Reserve Bank of Australia expressed comfort with the current level of interest rates AND their currency.  

"By dropping their easing bias, the RBA set off a wave of short covering in the Australian dollar last night that we expect to continue in the weeks to come.  In fact we are looking another 4% to 6% rally in the currency.

"By shifting from a dovish to neutral bias, the central bank is telling the market that they aren't worried about the recent deterioration in Australian and Chinese data as they expect the recent decline in the Australian dollar to balance growth in the economy.  

"While the RBA still believes that growth will remain below trend for a time and the unemployment could rise further before it peaks, the central bank doesn't feel that it is necessary to ease monetary policy further especially with inflation at the top of its 2-3% range.  

"Based on the rally in the Australian dollar today, the RBA's decision to shift to a neutral bias caught every one by surprise.  Having ended their easing cycle at a time when speculative short positions are near extreme highs, the central bank stands the risk of driving their currency sharply higher.

"Without the support of a potential rate cut, there is very little reason for traders to hold a significant amount of short Australian dollar positions especially given the negative interest rate differential with the euro and U.S. dollar."

According to Lien, the magnitude of previous rallies in the Australian dollar when speculative short positions were unwound was substantial.

Such relief rallies ranged from 3% to 26%  - and since short positions are higher now than they were in 2010 and 2012, BK Asset Management forecast that another 5% rally in AUD/USD would make the move from the bottom closer to the 8.5 to 9% rallies that we saw in 2012 and 2013.