Australian Dollar Monthly Outlook

12th June 2014

The risks are lined up for the Aussie, the reality of a slower China, lower global commodity prices, the need to reinvent itself following the mining investment boom and the tail risk that the RBA could cut the cash target given a deterioration in the growth outlook. Despite this we believe the near term direction of the AUD is higher. Simply put we are in a carry trade environment and the Aussie is triple A carry. Investors are prepared to overlook any fundamental flaws for the high yield the Aussie offers. Aussie has the other benefit of one of the few triple A currency which is reinforced by the recent Treasury budget.

The Aussie dollar is up 5.53% since the beginning of February, in line with a recovery in a number of carry currencies including the Brazilian real, Turkish lira and South African rand. The Aussie’s oblivion to fundamentals is further reinforced by a recent decoupling from the China trade. The Aussie was traditionally how investors took on exposure to China, as close trade links meant the Aussie dollar was effectively a freely floating Chinese yuan. The Aussie now appears to be impervious to the China risk as evidenced by a breakdown in the correlation between AUDUSD and copper. We believe the Aussie dollar will continue to find support until an external factor puts an end to the current carry trade environment. Two possible catalysts include expectations for tighter US monetary policy or the ECB failing to announce QE. The timeline of markets returning to the carry trade as speculation of ECB QE first emerged suggest ECB asset purchases may have directly addressed investors’ fears about a slowdown is US asset purchases. We see the Aussie trading to $0.94 by the end of Q2. The currency will likely come under pressure through the rest of the year as either one of the two scenarios evolve. AUDUSD will trade towards $0.88, $0.86 and $0.85 by the end of Q3, Q4 and Q1 respectively.

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