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Australian Dollar – Time to Buy?
Perspective | 28 May 2013
By: Kathy Lien
Articles (9) Profile

This article is written by Kathy Lien, Managing Director of FX Strategy at BK Asset Management

The Australian dollar (AUD) is a currency that Singaporeans watch very careful because of investments, offshore bank accounts, vacation plans or children studying abroad. I always get asked questions about the outlook for the Aussie at seminars in Singapore and given the recent slide in the currency, many of you are wondering whether it’s time to buy.

Over the past six weeks, the AUD has taken a nosedive, falling more than 8 percent in value against the US dollar. Against the Singapore dollar, the move is a more modest but still significant decline of 6.8 percent. The last time the AUD was this cheap for Singaporeans was in 2011 and it didn’t remain there for long.

However the dynamics now and then are different and the weakness of the AUD has not been limited to the US and Singapore dollars as the currency lost more than 7 percent of its value against the EUR, JPY, and GBP over the same period. The reversal of fortunes for Australia has come swiftly and aggressively. The AUD had been hit from all sides over the past month. The selling started with weaker Chinese data, which was followed by weaker Australian data. The Reserve Bank responded with a surprise rate cut and shortly thereafter, the US dollar (USD) started to rise causing commodity prices to plunge. Last week we learned that the Chinese manufacturing sector slowed even further, raising concerns that this vicious cycle could start all over again, driving the AUD to fresh lows.

From a fundamental and technical perspective, the AUD could be poised for further losses:

#1 AUD Is STILL Overvalued

According to purchasing power parity, the AUD is still overvalued. Even after the 8 percent decline in the currency the OECD’s measure of purchasing power parity has the AUD overvalued by 29 percent against the USD. Although the Economist’s Big Mac index puts the AUD’s overvaluation at only 4 percent, it is still expensive. While currencies can and will deviate from their fair values for long stretches of time, from a purchasing power parity perspective, the AUD is not cheap.

#2 Renewed Skepticism Of Chinese Growth Combined With Lower Commodity Prices Is Bad News For Australia

If the Chinese government’s official data confirms HSBC’s report that manufacturing activity contracted in May then Australia, who counts China as its largest trading partner could be in for some serious trouble. The double blow of weaker Chinese growth and lower commodity prices could put significant pressure on the Australian economy over the next few months. In the past, high interest rates helped the AUD shrug off lower commodity prices but now with the RBA (Reserve Bank of Australia) maintaining a bias to ease and the AUD falling sharply, foreign inflows may be insufficient.

#3 Charts Show Limited Technical Support

The following chart shows how there is very little support in the AUD/USD until 95 cents. The more significant support level is at 0.9385, a former breakout point. The pierce below the 50-month SMA is also fairly significant because it opens the door up for the move lower.

The Light At The End Of The Tunnel…..

Eventually the decline in the AUD/USD will come to an end and that may happen sooner rather than later. All the AUD needs to stabilise is a few positive economic reports. The recent rate cut by the RBA and the decline in the currency provides underlying support for the export dependent economy. Since many Australians shop from abroad it will keep demand domestic while at the same time making Australian goods more attractive, offsetting some of the pain from lower commodity prices. Tourism could increase and the housing market could benefit from external demand.

I would prefer to buy strength than weakness because when the AUD/USD recovers, the snapback could be strong. As shown in the following chart, if AUD/USD rises back above 0.9840, the trend has turned and we could position for a stronger recovery. Remember, at 2.75 percent, Australia still offers higher interest rates than other parts of the world. Also, the primary reason why the RBA cut interest rates was because they were worried about the damage that a strong currency could do the economy. Now that the AUD has fallen more than 8 percent from its April high, the bar is high and the economy would need to deteriorate significantly for the RBA to consider another rate cut.

Kathy is a well-known expert in the Forex world and has over 10 years of trading experience in the forex market. She is frequently seen and quoted on international media platforms such as CNBC.

Please click here for more information about this author.

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