AUD - the Pinocchio of the FX market

Daily Forex Fundamentals | Written by Jyske Bank | Jul 01 08 11:32 GMT |

'I've got no strings .........' If the Australian dollar could sing, it would probably sing this Pinocchio song right now. The dollar is dangling like it was controlled by a puppeteer, no longer attached to previously good macroeconomic and financial correlations.

The global slowdown has so far not affected the otherwise very growth-dependent currency. The AUD/USD rate is thus in an odd vacuum relative to the IMF's growth estimates for the next two years, apparently no longer attached to the otherwise good correlation between these two.

In our view, the resistance of the Australian dollar to falling global growth can mainly be ascribed to the currency's inherent commodity element. As one of the most well-known commodity currencies, AUD is currently benefiting from the historically high commodity prices. In fact, this is one of the only previously good correlations which still exists. This correlation is so strong that the other good correlations have been forgotten by investors.

Given our expectation of a coming correction in the commodity complex as a whole - and oil in particular - it is highly likely that the commodity-based bubble which AUD/USD is currently in will burst with resultant large price falls when the forgotten good financial/macroeconomic correlations begin to work again. In relation to the purchasing power parity, AUD is extremely overvalued against USD. The expected dollar appreciation and the adjusted commodity prices risk hitting the Australian dollar like a 'double whammy'.

Financially, speculative AUD positions indicate that professional investors have smelled the rate. They have quietly begun to reduce their long positions which have by the way not supported the large rise in the AUD/USD rate since last summer. The high AUD/USD has thus not been supported by unhampered appetite from speculative investors. This is in itself a warning of a market without much weight, which may be strongly destabilising for a currency pair over time.

Technically, the AUD/USD uptrend is still intact according to our long-term monthly model, although the trend has moderated lately. If the long-term moving average currently at 92.40 is breached, it will be the first signal that after all the law of gravitation also applies to AUD/USD, and that a new downtrend may be in the making.

Due to the above, the invisible puppeteer may not be so invisible after all. To equate high commodity prices - whether driven by financial greed or fundamental demand - with a strong/stronger AUD is the same as having blind faith in Stromboli!

Speculative AUD positions lose momentum

• The rising AUD/USD rate has since mid-March not been supported by a rising number of long AUD/USD speculative positions (in terms of exchange-traded FX futures)
• Such 'disagreement' between the actual price development and speculative positions is to be labelled divergence
• Such divergence is a signal that the price development is not well-founded and that the market may quickly be short of weight with resultant high price declines if investors try to get out of the 'door' at the same time

Rising AUD/USD NOT supported by growth

• It is quite odd that the rise in AUD/USD is not on level with the global growth estimates by the IMF
• Expected lower global growth for both 2008 and 2009 should realistically have driven the growth-dependent AUD lower, but this has not been the case yet
• As a commodity currency the correlation between global growth and thus the demand for commodities has been an important parameter for the price development of AUD

AUD/USD hovers above the purchasing power parity

• AUD/USD is currently hovering above the purchasing power parity
• I.e. domestic macroeconomics do not support the vehement rise in AUD/USD, which is why AUD is currently very overvalued against the historically low USD
• Although early in this decade, AUD was undervalued against USD for a long period, it is worth noting the current extreme situation
• Extreme situations tend to be corrected all of a sudden

Jyske Markets - FX Research http://www.jyskebank.dk/finansnyt

The analysis is based on information which Jyske Bank finds reliable, but Jyske Bank does not assume any responsibility for the correctness of the material nor for transactions made on the basis of the information or the estimates of the analysis. The estimates and recommendation of the analysis may be changed without notice. The analysis is for personal use of Jyske Bank's customers and may not be copied.