Forex Investment and Currency Trading

Current sentiment for the A$ is very bearish…

The overall atmospherics remain downbeat for the AUD. As highlighted by the chart across, commodity prices have moved sharply against the currency and we could add the yield spread and domestic data to this picture. However, it must be asked how much of this bad news is already priced in? Since its peak in mid July, the AUD has fallen by close to 35% in its most violent correction since the currency was floated in December 1983. There seem to be lots of other compelling reasons to own AUD here - funding markets are starting to thaw, measures of systemic risk in the financial system such as bank CDS spreads have narrowed considerably, RBA Governor Stevens and RBA commentators are all suggesting that there is less RBA easing in pike due to the 1ppt fiscal easing along with Government measures to assist bank funding, and lastly an array of volatility measures are starting to come off their extremes - swap spreads, FX implied vol, the VIX and the MOVE index to name a few. In addition, flow data indicates that the currency is getting well into oversold territory. So is a good contrarian view to bet on AUD strength as we move into 2009?

… creating the potential for a bounce as risk aversion drops
To be sure, recent price action in the AUD has been very disappointing but the bottom line is that the AUD is simply tracing out a wide 0.65-70 range. There is nothing terminal or decisive about the price action which suggests another major leg lower is unfolding. All the aforementioned factors argue for a topside break into year’s end with potential for a run toward 0.75¢. However, any bounce back to this level may present a good opportunity to re-establish shorts and there are concerns that a bounce of this magnitude is going to materialise at all.

… but global recessionary fears are dominating markets
The deteriorating global outlook has weighed heavily on commodity prices. Much focus has been on base metals, which have fallen sharply over the past 6 months and the LMEX index currently sits on very important multi-year support levels. However, recent sharp falls in spot bulk prices are particularly discouraging since they have driven much of the terms of trade boom and thus accounted for much of the of the enormous multiplier effects through the economy. It has been generally assumed that once sentiment stabilises the AUD could roar higher.

Global sentiment is unlikely to turnaround soon
Whether or not global growth is as weak as some analysts are forecasting over the next 3-6 months remains to seen but it’s difficult to imagine sentiment improving rapidly as we move into 2009. The PMI around the globe have generally been following the US lower since March of this year.

The real money community has been caught out badly by the AUD’s sharp slide. This community built up an enormous structural AUD long in the 3 years to 2008. One suspects the lack of selling could in part be based on faulty assumptions about Australia’s terms of trade. That this community remains long is another reason to question just how much the AUD could bounce near term as risk appetite stabilises - they are likely to be persistent sellers into strength.

Sentiment surrounding the global outlook is likely to remain very downbeat over the next 3 months. The flow on effects to commodity prices and Australia’s ToT will continue to weigh heavily on the currency.

All of the above paints a fairly bearish picture for the AUD but it’s worth noting that outside of the US and Japan, there is plenty of scope for more accommodative monetary policy, particularly in the UK and Europe. In China, easing monetary policy along with fiscal initiatives should help growth from falling too dramatically.