Australian Dollar

The Value of the Australian Dollar

The Australian Dollar has fallen around 11% over the last month. This is a very large and very rapid move for the currency of a major nation. How would you like to end up with 11% less in next week's check? This is similar to what the average Australian will feel with every purchase of every imported good or service, just think of it as $4.50 gasoline and you'll get an idea for the feel of it. Our outlook suggests that the change in the macro is correct but its initial impact has been over cooked.

The primary big picture changes that triggered this sell off are twofold. First, the slowing Chinese economy has been a primary destination for Australian raw materials. Secondly, the U.S. Federal Reserve Board announced its intentions to begin siphoning off the Quantitative Easing stimulus. This has triggered the unwinding of the carry trade.

China is Australia's largest trading partner with total exports to China comprising more than 5% of Australia's Gross Domestic Product (GDP). The impact of recent downward revisions to Chinese GDP has taken the wind out of the Australian economy. The International Monetary Fund (IMF) cut their forecast for Chinese growth from 8% to 7.75% for 2013. HSBC and Barclays announced larger cuts in their projections and see Chinese growth at 7.4% rather than their previous estimates of 8.2% and 8.1% respectively for 2013. GDP forecast revisions of more than.5% tell us two things. First, economists aren't great at forecasting when their margin of error is +/- 10% per quarter. Secondly, a.5% cut in Chinese GDP still leaves them in the enviable position of having the largest, strongest economy in the world.

The carry trade is based on borrowing cheap money from one country to buy assets in another country. The two primary components of a carry trade are the interest rate differential and the exchange rate between the two countries. The trade makes sense in a stable marketplace. Dollars borrowed in the United States at.25% are used to buy Australian treasuries yielding better than 3% and recently as high as 4.25%. More importantly the Australian Dollar held its own throughout the global financial crisis. This made it a safe haven as the highly leveraged U.S. And Euro markets raced each other to the zero lower bound leaving Australia to benefit from both higher interest rates and currency appreciation. That's a win/win in the carry trade.

The money that has poured into Australia can be seen in the rapid growth of their currency reserves. Foreign currencies were repatriated post haste during the financial crisis. Australia's foreign exchange reserves declined from the all time high of more than $80 billion in May of 2007 down to $30 billion by January of 2008. Australia's current reserves haven't been this high since June of last year. June of 2012 also marks the low point for their currency in the last year.

The macro issues surrounding the global currency wars are beyond the scope of my day-to-day trading. However, the knee jerk response in the global currency wars due to Ben Bernanke's suggestion that the Fed may begin to taper off the Quantitative Easing programs combined with the volatility in the Asian currencies and stock markets has created an overly bearish situation in the Australian Dollar. Their healthy balance sheet, excess foreign reserves and primary business of raw material and agricultural exports places them in a position to control the fortunes of their own currency, stock market and economy as a whole. They still have all the tools that we've already used to fight an economic downturn of their own. In fact, I'd say they're holding a full clip while here in the U.S. We're hoping we can pull back just long enough to reload. Therefore, the current prognosis lies in favor of a higher Australian Dollar going forward.

The commercial traders are well aware of the situation and they've been on a torrid buying spree in the Australian Dollar. In fact, they started buying in earnest once the Australian traded down to par (even money) with the U.S. Dollar, nearly doubling their net position over the last six weeks. We believe that the heavy commercial buying will cause the sell off to grind to a halt and protect us from much more downside risk. Therefore, we'll be buying the Aussie as soon as we get some type of early technical reversal to trigger our long trade. We will then place a protective sell stop underneath the low for this move. Based on the current ranges and swings, we would expect to take profits between $.9750 and par to the U.S. Dollar.

Andy Waldockhttp://www.commodityandderivativeadv.com866-990-0777.

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