4 Reasons Why the Aussie May Continue to Wipe Out

The currency waves have not been kind to the Aussie lately. After topping out at 1.0800 earlier this year, AUD/USD has come crashing down and is now trading 1,000 pips lower at .9800.

Unfortunately, the near future doesn’t look too sunny either. Here are four reasons why the Aussie may continue to slide down the charts.

Interest Rate Cuts

It’s amazing to see that while AUD/USD has dropped over 9% since its 2012 highs, most of the decline has come in May. The spark that set the flame? The RBA’s interest rate cut!

A rate cut was widely expected from the Reserve Bank of Australia (RBA), as it refrained from doing so in March. However, what the markets weren’t planning for was a 50-point rate cut! This shocked the markets, as early projections were for a more timid 25-point decrease. This brought the base rate down to 3.75%, its lowest level in more than two years.

If you ask me, we could be in line for a couple more rate cuts down the road. Recent history shows that the RBA has been rather proactive with regards to monetary policy. It responded to the 2008 financial system collapse with a series of repeated rate cuts, bringing rates down from 7.00% all the way to 3.00%.

With Australian economy suffering through an up-and-down performance, I wouldn’t be surprised to see the RBA try to energize the economy by implementing further rate cuts later this year.

Gold Losing Its Luster

Over the past three years, the Aussie has been one of the most resilient currencies, as the commodity boom helped give it good support. Specifically, gold nearly doubled from its 2009 levels to hit an all-time high at $1,921 per ounce. Take note, the Aussie and gold prices are highly correlated, so whenever we see gold prices rally, the Aussie normally follows suit.

Recently however, the Aussie has failed to receive any backing from commodities, as traders have been dumping then left and right. Gold prices have slumped over the past few weeks, falling more than 12% from its 2012 highs. As I pointed out a few weeks back, the combination of gold losing its hedging appeal and the need to cover margin losses helped accelerate gold’s decline.

If gold continues to lose its luster, this could mean more trouble for the Aussie down the road.

Weakness in China

While China may still be one of the hotter nations, it clearly isn’t the same economic monster we’ve seen over the past decade.

The HSBC flash purchasing managers’ index clocked in at 48.7 in May, down from the 49.3 reading we saw in April. This marked the seventh consecutive month that the index was below the line-in-the-sand 50.0 mark, indicating contraction in the manufacturing industry.

Meanwhile, the Chinese government has inadvertently acknowledged the weakness in the domestic economy by lowering the reserve-requirement-ratio by 50 basis points in order to encourage more loaning. As it stands, bank loans are projected to come in at 7 trillion yuan, way below the government’s lower target of 8 trillion yuan.

Remember, China is one of Australia’s largest trade partners. If it continues to slow down, Chinese firms could lessen their demands for raw materials from Australia, which in turn would less demand for the Australian dollar.

Euro zone problems

Lastly, let’s not forget about overall risk sentiment.

The recent rumblings from the euro zone helped trigger the sell-off in higher yielding currencies this past May. With the all the rumors that Greece may get kicked out of the euro zone, the political bickering between Angela Merkel and Francois Hollande, and rising Spanish and Italian bond yields, traders, fund managers, and other financial players started unloading their positions in riskier assets.

There’s no telling how this will all play out, so we can probably expect traders to hold back a bit before buying the Aussie.

Looking ahead

With all this May weakness, AUD/USD has been trading smoothly in a descending channel. With all these reasons for the Aussie to fall further, I wouldn’t be surprised to see the pair drop all the way down to former lows around .9400 before finding any solid support.

Of course, just keep in mind that the markets are fickle and that anything, and I mean ANYTHING, can happen in the markets. The best we can do is practice good risk management skills and keep our risk in check!

3 comments

  1. Granticus_Maximus

    Great post. My short entry was triggered seconds before the rate cut kicked in at 1.04120, thanks to a quick spike before it plummeted, but didn’t hold on to it as long as I could/should’ve… Looks like there’s still room for making pips in it though. I agree with the points you’ve made. Things aren’t looking good for the Aussie.

    The great thing about knowing forex, is that I ordered my USD for a holiday I’m taking (I’m Aussie) the day before the rate cuts, knowing the implications that it would bring, and like you I had a strong feeling it’d be cut by 50 basis points. Saved lots of $$.

    Keep the great posts coming mate, they’re always very interesting and informative!

    Reply
    • Granticus_Maximus

      And now that the AUS/USD has broken the channel, it’s been having trouble breaking the previous Dec 2011 daily low for the past few hours. Could that support now play as resistance at around 0.9860?

      Reply

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