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“Australia will do very poorly between the second half of October and January-February.”

                           John Taylor, FX Concepts

FX Trading – Follow the Leader: Australian dollar the risk driver here?

There is no mistaking the role the Australian dollar plays in currency speculation. It is easily THE risk currency. It’s got growth (particularly the tight connection to China and the rest of Asia) and interest rates on its side. So when speculators are looking to capitalize on risk appetite, or when investors are looking for an extra yield boost, they look towards the Australian dollar.

We were recently asked by a member of CCPRO why we weren’t up to snuff on our Australian dollar recommendations. Good question.

Considering the feel of the market we’ve had over the last couple weeks and months, there’s been little consistency in investor sentiment. While we’re not surprised the Australian dollar has made good in a marginally risk-on environment, we have been a bit surprised about how decisively the Australian dollar has moved to test its highs amidst less certain market sentiment.

As we’ve evaluated markets along the way we’ve been looking for a place to enter, i.e. waiting for the Aussie to settle down a bit with the hopes of capturing what we’d consider a “better price.” Unfortunately those better prices haven’t surfaced in the Aussie’s latest move, and we’ve been on the sidelines.

AUDUSD Daily: quite the rocket ride since late August.

Also note the arrow – that marks Friday’s price bar which touched a new high intraday but close flat. Typically that’s kind of price action is going to incite some bearishness in subsequent next trading sessions.

Not so much, this time.

Perhaps the entire risk-taking complex is taking its cues from the Aussie today; this chart of S&P 500 futures shows the same price action (a big reversal after touching new highs on Friday that was met with buying today, rather than selling as would be expected.)

S&P 500 Futures Daily:

The Australian dollar has been dealt a nice boost today from the Reserve Bank of Australia. The RBA stepped up to brag about robust growth in Australia in the near-future and expressed the central bank’s pledge to managed growth accordingly with policy adjustments, i.e. more interest rate hikes. The bank’s Governor, Glenn Stevens, said:
"We expect — and indications from businesses are that they do as well — that resource sector investment will rise further, as we experience the largest minerals and energy boom since the late 19th century."

"Even with continued caution by households, that probably means that overall growth, which has been at about trend over the past year, will increase in 2011 to something above trend."

The RBA is next set to discuss and announce changes to its monetary policy on October 5th.

As we look for an opportunity to enter long AUDUSD – assuming we don’t get the implosion in risk appetite of which our often doom-and-gloom analysis forewarns – we expect we could see the Aussie continue its rally until the first week of October (at least) when the “buy the rumor, sell the news” mentality comes into play and could represent some resistance.

As for the big picture, this weekly chart shows the next technical hurdle at the 2008 high of 0.9850 – it is a big one but many traders are likely aiming for it.

AUDUSD Weekly:

As you know, currencies tend to over- and under-shoot there fundamental values. Yesterday we noticed a story on, saying the Aussie was 27% overvalued on a Purchasing Power Parity basis. That doesn’t mean one should step in front of it and short. But it does mean if the global macro environment changes, we expect the Aussie to fall hard. And we will be recommending you short AUDUSD — everyone’s favorite long currency pair — when we think a change is afoot.

Speculator Open Interest Levels in the Australian dollar futures listed on the CME (from the CFTC Commitment of Traders Report Sep. 14th 2010):

Long (bullish) = 74,076 contracts
Short (bearish)= 17,407 contracts

A one-way bet in the making!