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Australian Dollar On Edge After a Good Run

By    |   Thursday, 19 Jun 2008 05:05 PM

Even the best of currencies eventually chip away at their own fundamentals by doing so well.

Now what the heck does that mean? Well, when a country does well economically, inflation goes up along with it. In order to keep inflation from rising too quickly, interest rates have to go up, too.

As rates go up in an economically sound country, money is attracted to it because it appears to pose little risk while offering a great return. So money floods into the currency, driving it up.

That's what is happening to the Australian dollar. The AUD/USD exchange rate has gone through the roof over the past year, as have Australian interest rates.

After a while, high interest rates plus a high exchange rate puts a lot of wear and tear on the economy. Up until now, this economy has been unstoppable. Even the U.S. slowdown hasn’t affected it nearly as much because demand from China has largely overridden the impact.

That’s why the Aussie has prospered so much over the past year. Money could run there to hide from the subprime fallout and earn a high rate of interest — 7.25 percent vs. the shaky 2 percent in the United States right now. So it was a no-brainer, until now.

So what is changing? Australia’s employment, that’s what.

Here’s why it’s such a big deal. Australia has created jobs every month since October 2006. Wow! Even in the midst of a global slowdown, credit crunch, and subprime crisis mess. Now that’s impressive.

So while one month isn’t a trend, just the fact that there were job losses may discourage the central bank from raising rates further.

After all, the economists were expecting 13,500 jobs to be created this past month. Instead, there was actually a 19,700 job loss. That’s a huge difference.

Now if this were the only downside to the AUD/USD pair, then that would be one thing.

However, there’s more to consider on the U.S. dollar side of the pairing.

The buck has been strengthening this week. It appears that the big money is taking the U.S. serious in its latest round of jawboning.

Why? Well, several Fed officials now have talked about fighting inflation and the possibility of rate hikes in the U.S., and one of those officials was none other than Fed chair Ben Bernanke.

Then Treasury Secretary Paulson said he supported a strong dollar, and that he wouldn’t rule out intervention.

Now, the first part of that sentence we’ve heard a million times. But that last part is what got the market’s attention. He was responding to a direct question from a reporter, but the fact is he hadn’t mentioned intervention before, ever.

Then even President Bush reaffirmed support for the dollar as well.

So if you figure either one of these guys, especially Bernanke or Paulson, is serious, then there’s good reason to not short the dollar any longer. If they aren't bluffing, the risk of doing so just went up exponentially.

I don’t know too many traders who want to call that bluff and find out the hard way.

You see, the U.S. has intervened in its currency before. It’s just rare, and it only does so when conditions are at historic extremes. Well, we’re at one of those points now, and we’ve been at it for months.

So, the powers that be seem to feel that they might need to help out the buck to get it headed in the right direction.

If that wasn’t enough, there was a scare that the G-8 countries also might collectively decide to support the dollar.

That’s happened before too, and when it does, historically, that's the turning point for the greenback.

So there are a lot of land mines out there for those who short the dollar. This has caused the dollar to rally against most currencies this week.

You never know, one or more of them might actually be serious.

And with retail sales coming out stronger, the U.S. Fed has room to seriously consider a rate hike to squelch inflation. (Retail came out about twice as strong as expectations. Looks like consumers used those tax rebates to buy food and gasoline this past month.)

So there are a lot of fundamental snags out there right now in favor of the dollar and one important factor against the Aussie dollar.

This has caused the first breach of the AUD/USD’s long-term trend line in about a year. So now we have not only a fundamental chink in the armor, but also the technicians out there are taking note as well.

If it turns out that the fundamentals really are shifting, then that breakdown of the uptrend line really could hold. We’ll find out shortly.

In the meantime, I’d be leery of being long the AUD/USD. Believe me, this is probably the first time in more than a year that I’ve gotten bearish on this pair. I’ve been an AUD/USD bull for a long time, and rightfully so.

However, you have to read the writing on the wall and always re-evaluate your position.

It’s possible that AUD/JPY and AUD/NZD could still hold up, but I would not be long the AUD/USD right now.

However, rather than turning around and shorting AUD/USD, I’d rather short a currency with more flawed fundamentals at the moment. So if I were looking for a currency to short, that would be the New Zealand dollar (NZD/USD) on a rally upward.

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SeanHyman
Even the best of currencies eventually chip away at their own fundamentals by doing so well. Now what the heck does that mean? Well, when a country does well economically, inflation goes up along with it. In order to keep inflation from rising too quickly, interest rates...
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2008-05-19
Thursday, 19 Jun 2008 05:05 PM
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