Forex Traders: More Decline to Come for the Aussie

August 1, 2013
By Vlad Karpel

The temperature isn’t the only thing that’s rising Down Under. Since bottoming in 2008, the Australian dollar (AUD), the Aussie, has been under a massive uptrend, hitting-breaking record levels in 2011. A rise on benchmark rates by the Reserve Bank of Australia (RBA) and an ambitious easing program for the U.S. dollar all weighted very positively on the Australian economy and on the Aussie. From a close near 0.605 on Oct. 27, 2008 against the US dollar (USD), the AUD climbed up without looking back until hitting 1.10 on July 27, 2011. In less than 3 years, the Aussie rose an impressive 83%, an enviable return for any Forex trader.

Unfortunately for Australian authorities, the rise in the official cash rate had some negative consequences. With the U.S. Federal Reserve keeping interest rates near zero and injecting massive amounts of cash into the economy through bond buying, the situation was perfect for a rise in the Aussie, but it also helped deteriorate the Australian trade balance. Meanwhile, a slow paced global recovery became a threat to a resource-rich export economy like Australia. Demands from China were also declining with a negative outlook attached, which was detrimental given that exports to China is 30% of total exports for Australia.

It is not difficult to understand how important it is to look at Chinese fundamentals before making projections for Australia’s future. As long as China grows at record pace, Australia will be in a stable position. However, when that pace slows, Australia could be in deep trouble.

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The Chinese economy grew at a pace of 9.3% between 1970 and 2011– more than triple what the European and Americans experienced. In just 7 years, the Chinese were able to double the value of its economy. In 2009, a massive stimulus package was approved in China to fight global turmoil and avoid any derailing or soft landing. This, in turn, has helped both the Australian economy and the Aussie rise.

However, after 2011, the situation has been changing for the Aussie.

Global growth has been growing slower than expected and growth in the Chinese economy retreated to 7.5%. Commodity prices, such as gold, also dropped substantially. The Australian trade balance deteriorated fast, economic growth decreased and the Australian Reserve Bank had to cut on its key rate from 4.75% to the current 2.75%.

From a high near 1.10 the Aussie retreated to its current 0.92 level, having crashed 11.5% YTD. At this point one might ask what to expect about the near future. Is the Aussie bottoming and changing direction, or should we expect more decline to come?
In our view, there’s more decline to come. First of all, China is growing less than expected and Chinese authorities will be happy with lower growth rates than in the past. China’s infrastructure driven economy, in which government spending used to represent 50% of GDP, is changing into a more consumption-driven economy. With government investing less than in the past in infrastructure, demand for iron ore will certainly drop substantially, which is a major blow for Australia exports. Secondly, the US will have to taper on its QE program, which means it has to stop debasing the US dollar. Sooner or later, not only the asset purchase program will stop but also interest rate expectations will start rising, which decreases the interest rate differential between the AUD and USD with negative consequences on the Aussie, as we don’t expect the RBA to move its key rate higher anytime soon. Thirdly, global growth will take some time to recover and global demand for commodities will grow slowly, such that Australia will need a weakened currency to help improve its trade balance.

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