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Why The Aussie Came Back And Will Stay

Currencies | Apr 04 2013

– Aussie To Stay Strong This Year
– Greenback gains to moderate
– Yen will weaken further
– AUD rangebound between 1.04-1.06

By Andrew Nelson

If you want to know why the Aussie bounced right back to the 1.04s from the pressure that pulled it down to 1.01s you’ll need to know a little bit more about recent and not so recent history.

From pretty much the beginning of this year the Aussie started to feel the weight of increasing pressure and there were two main contributing factors: a dramatic weakening in the JPY and a big rally in the USD right at the same time.

The yen freefall we’ve seen over the past few months put most of the rest of the non-Japan Asian currencies under some downward pressure as well. This was in part due to the fear of losing competiveness against one of the region’s major export competitors, Japan.

Currency analysts at Commonwealth Bank point out that the AUD/USD maintains a very tight relationship with non-Japan Asian currencies. In fact, CBA notes it is often used as a proxy for Asia because of the better liquidity in the AUD and because of Australia’s very close trade links with the region. Thus, concludes CBA, the AUD/USD was weakening in tandem with weakness in the JPY and by extension, the decline in non-Japan Asian currencies.

At the same time there was a big run in the USD on the back of improving economic data, capital inflows into equities on improving markets, and Italian election concerns also lent plenty of support.

And while US markets continue to rise, providing even more support for the greenback, CBA sees no way Asian currencies can continue to underperform, while the yen alone just can’t drive the AUS/USD anywhere. The bank thinks the cross has already come back to dancing to its own tune.

The reasons why are numerous. Firstly, CBA points out that AUD/USD option volume during the drop began to decline from already low levels. When there are limited volumes, relative economic health drives exchange rates. Australia’s terms of trade also remain at quite elevated levels. This provides significant support to the Aussie and will also help in preventing a big drop in the AUD.

Next, while central bank buying of AUD government bonds has started to slow, there are still large substantial foreign direct investment (FDI) inflows into Australia. This is now providing increasing support, with the bank thinking the trend of rising FDI inflows will have continued into Q1 2013.

The Australian economy is also nowhere near bad enough to support the prospect of multiple interest rate cuts by the RBA. In fact, the RBA said at their March 5 policy meeting that the substantial amount of easing that has already been undertaken was starting to work in the domestic economy.

Lastly, the Fed has made it patently clear that the push of current open-ended quantitative easing is not likely to change any time soon despite the signs of economic improvement.

CBA’s current expectation is for further depreciation in the JPY, mainly on the back of the collapse in Japan’s current account surplus. The beginning of the new Japanese year could also see some JPY depreciation as Japanese investors look to increase offshore investment. The bank also thinks that the new monetary policies from the new government and new BoJ head may also contribute to further JPY weakness.

Given this backdrop, Commonwealth expects the AUD/USD to remain pretty much range-bound between 1.0200 and 1.0600. The bank also sees further upside in both USD/JPY, pushing from 93.55 now to 100 by September, while the AUD/JPY is expected to push from the current 97.8 to 104 by September.

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