Why Australian Dollar Strength is Unlikely to Last

The Australian dollar (AUD) is forecast to find short-term strength as the follow-through from the weekend announcement of Chinese financial stimulus is felt.

“If 1.00 does break, I would not be at all surprised to see a sharp 3-5% drop before common-sense and fundamentals kick back in.” – Sean Lee on the AUD/NZD.

"GBPAUD retains a bull bias for a move to 2.00+" - Lloyds Bank Research.

The Aussie has found strength over recent sessions after Chinese authorities announced they would cut reserve ratios for their banks in an effort to stimulate lending.

The new efforts to boost the economy of Australia’s largest export market will certainly provide some Aus dollar support in the near-term; but it is argued that it will still fall to Australia’s own central bank to pick up the slack and cut rates further.

Such a cut to interest rates will undermine the AUD in coming months and leave those hoping for a stronger domestic currency wishing they had acted sooner.

Additional impetus has come mid-week with the release of stronger-than-expected inflation data. ANZ Bank argue this data is unlikely to deter the RBA from cutting rates again in 2015.

As we can see from the following rates, the Australian unit is firm:  

• The pound to Australian dollar exchange rate (GBP-AUD) is trading lower at 1.9241.
• The euro to Australian dollar exchange rate (EUR-AUD) is lower at 1.3830.
• The Australian to US dollar exchange rate (AUD-USD) is 0.21 pct higher at 0.7742.

Beware. All currency quotes mentioned above refer to the wholesale market. Your bank will affix a discretionary spread when transferring money internationally. However, an independent provider will seek to undercut your bank's offer, thereby delivering up to 5% more currency in some instances. Please learn more.

A Key Level is Being Fought Over in AUD-USD

The one currency that has the best chance to rally against the Aussie dollar at the present time is the USD.

According to analyst Karen Jones at Commerzbank the AUD v USD exchange rate is currently locked in a battle over the resolution of a key technical juncture:

“AUD/USD has dived back below the 55 day ma and the 2014-2015 resistance line should now act as support .7737/42 – this calls the break higher into question.

“We note that the intraday Elliott wave counts are more positive and provided dips are contained today by .7675/65, we would allow for further upside probes for this week.

“Initial resistance is offered by the February and March highs at .7912/38 – key resistance is regarded as the .8034 early January low and a close above here is needed to negate medium term downside pressure.”

Analyst Ross Woodfield at Blackwell Global is touting the prospect of the longer-term downtrend kicking in at this point:

“The latest bearish wave that is forming should take the AUDUSD pair down towards the recent lows just above the 0.75 cent mark and that could be put under serious pressure if the RBA does cut rates in two weeks.”

Pound v Australian Dollar: Trend is Turning

We have, on many occasions in 2015 talked about the upward-facing channel dictating moves in GBP-AUD.

This move now looks like it is breaking to the downside which tells us that the prospect of a 2.0 exchange rate in GBP-AUD in 2015 is becoming more distant.

Not so argues Lloyds Bank Research who reckon 2.0 is still possible.

In a note to clients in mid-week the UK bank suggests, "GBPAUD retains a bull bias for a move to 2.00+, with the over-night gains in the AUD on the back of the ever so slightly stronger CPI data expected to be limited. Key support in GBPAUD 1.90/1.8850 support."

Watch out for increased volatility in this pair over the course of coming weeks as an uncertain election takes place and a potentially weak government is installed.

AUD v NZ Dollar: Parity will Happen

Turning to the Australian dollar v New Zealand dollar forecast, the potential for a test and breach of a 1:1 exchange rate is on the cards.

Sean Lee at Forextell has told us:

“There is reported to be massive optionality around 1.00 in the AUD/NZD cross and I expect to see a significant test of this level this week. Forget about fundamentals, this is purely about finding the weak side of the market in the short-term.

“The fact the recent rally stopped squarely at technical resistance near 1.0220 is a strong confirmation that the downtrend is still in charge.

“If 1.00 does break, I would not be at all surprised to see a sharp 3-5% drop before common-sense and fundamentals kick back in.”

Kathy Lien, analyst at BK Asset Management, is also convinced the Australian and New Zealand dollars will reach par. Falling below 1:1 will however provde difficult:

"The currency pair looks poised for a move to parity and this time, the level could break.  When that happens we don't expect a swift move lower and instead anticipate a quick bounce above parity after stops are swept out."

Unease at Martin Place

Over at RBA headquarters there is a decided air of unease concerning economic trajectory in our opinion.

Currency markets, have obviously taken a more hawkish approach to the minutes, but we heard a dovish tone that seeks to maintain an easing bias.

The minutes stated that, “further easing of policy may be appropriate over the period ahead.”

Elsewhere, “the board would continue to assess the case for such action at forthcoming meetings.”

There is also an increasing uneasiness about the housing market and the implied household leverage – the one thing that will hold the Bank back from engaging in AUD-negative rate cuts is the potential this will have in fuelling a debt bubble.

If this theme plays out further then expect further support for the Aussie to grow.

Nevertheless, for now we take the position that at least one further rate cut is in prospect.

“The Aussie dollar is staring down the barrel of further rate cuts as the economic slowdown in China flows on to Australia. China’s recent round of stimulus will support the Aussie, but this will only go so far and a cut from the RBA will likely see the recent lows tested,” says Woodfield in a note to clients.

Some of this liquidity will likely find its way to Australia and the currency could indeed be benefiting on the anticipation.

The bad news for Australia is that this will not be enough and Australian unemployment is expected to climb.

Beyond the employment picture, “sub-trend consumer spending, collapsing mining investment and the re-emergence of poisonous politics are overpowering any positive vibes from buoyant house prices and construction,” says Annette Beacher at TD Securities. 

TD Securities is one major analyst that is forecasting a weaker AUD profile in 2015.

On the issue of unemployment, note that last week we saw a surprise dip in unemployment from 6.3% to 6.1%.

The RBA has said it wants to assess the effect of the last rate cut before deciding whether to cut again, but the market continues to see through the recent figures and continues to factor in a further cut to the base rate.

This will ultimately keep the Aussie dollar under pressure in the longer-term.