The Reason for the Dip in the AUD/USD Pair

Technical charts of AUD/USD are presently showing signs of bullish trend reversal, stemming from the drop-in value for the Australian dollar, which has dropped as low as .7024.

USD To AUD

This is the lowest level that has been since February 2016, where it sat at .7040. It is under intense fundamental pressure, for a series of reasons.

  • Australia has close economic ties with many emerging markets across Asia, including China. Since it is considered a highly-liquid currency compared to many Asian counterparts, the movement of AUD is often reflective of sentiment shifts towards the Chinese economy. The Chinese yuan has also hit decade-lows.
  • There are growing concerns about trade wars, which naturally bring with it a general atmosphere of market risk aversion. This tends to play against growth-linked currencies such as the AUD, due to its link to the trade spat’s two great protagonists (China and America) in various intertwined ways.
  • The currency pairing is threatened by the gap in monetary policy approaches between the Reserve Bank of Australia and the US Federal Reserve. While the US Federal Reserve seems committed towards raising interest rates based on the President Trump’s reservations, the Reserve Bank of Australia seems set to keep its own key Official Cash Rate at its 1.50% record low for many months yet. Futures markets still don’t predict a move for all of next year.
  • Political risk is another negative that is plaguing the value of the AUD. There has been a great deal of activity going on at the top of Australian politics in the past decade. The country has had six Prime Ministers since 2007 and the ruling party’s loss of a recent key by-election in Sydney last week makes it safe to assume that 2018 could bring a seventh Prime Minister.
  • Unemployment has fallen to 5.0% in September, the level which the Reserve Bank of Australia has been targeting based on its monetary policy statements. Should growth firm lean more towards the upside around 3.0% in 2019, this would provide more reason for the Reserve Bank of Australia to raise interest rates.

Justin Grossbard from Compare Forex Brokers said that the Australian Dollar doesn’t appear to be a screaming buy at the moment. The second quarter’s annualized rise of 2.1% put inflation back within the Reserve Bank of Australia’s 2-4% target band for the first time since the final quarter of 2016. If it holds up, or even edges ahead, that brings about the possibility that the momentum lower in AUD/USD could be halted, even if it is unlikely to stop for long. After all the Reserve Bank of Australia’s mandate is to keep price rises within that band ‘over time,’ not merely to get them up there on occasion. Signs of sustainably higher prices could possibly give the AUD a degree of support and, assuming the absence of more bad news.

Australian Inflation

There is the chance that the AUD will stabilise over the longer term as many expect the Reserve Bank of Australia to turn hawkish in the latter half of 2019. That would support a narrowing of yield differentials with the US. Additionally, the undervaluation should also support some AUD strength. The Australian dollar has depreciated by 4.1% against the USD since this past July, and many remain bearish on the unit’s trend in the near term. It makes most sense to revise the forecast for the pair to average USD0.7450/AUD in 2018, ending the year around USD0.7000/AUD.

It’s important to bear in mind that the Reserve Bank of Australia appears likely to remain on a neutral stance through 2018 to keep the currency competitive. Despite AUD’s slide against the USD, the currency’s strength remains relatively stable (if not only slightly weaker than its 10-year average) on a trade-weighted basis. This implies that the central bank is unlikely to raise interest rates to support the currency in the near term. However, given the tendency for currencies to mean revert towards their long-term averages, this would point toward a slight strengthening of the AUD in the longer term.

The saving grace for the AUD would be the combination of an increase of demand of Australia’s exports throughout Asia, especially China. There would also need to be a greater demand of Australian resources, such as commodities including iron ore and coal. And ultimately, the volatility across all spectrum, from global growth forecasts to political climate, will play a significant role in the value of the AUD increasing.

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