Justin Pugsley - Justin has over 20 years experience writing about markets, economics and finance. He has worked for a number of leading media organisations such as Agence France Presse (AFP), Dow Jones, Wall Street Journal, Thomson-Reuters, British Sky Broadcasting and McGrawHill.
Justin Pugsley
Justin has over 20 years experience writing about markets, economics and finance. He has worked for a number of leading media organisations such as Agence France Presse (AFP), Dow Jones, Wall Street Journal, Thomson-Reuters, British Sky Broadcasting and McGrawHill.
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Fundamentals will continue to bear down on AUD during H1

As January has progressed it has got steadily worse for commodities and risk assets and unsurprisingly AUD got caught up in the turmoil and stands to lose more ground during the first half of this year.

For the third time since September 2015, AUD/USD found itself below the crucially important psychological level of 0.7000. However, the deteriorating fundamentals in the global economy and in commodity markets could see AUD/USD reach 0.6500 during Q1 or Q2.

The twin drag on AUD are plunging commodity prices, meaning less export revenue and China’s slowing economic demand particularly for many of the industrial raw materials Australia produces. Iron ore is a particularly important Australian export to China where prices have fallen over two-thirds in the last few years – though it shows signs of stabilising since early December despite problems in the global steel industry.

Fundamentals will continue to bear down on AUD during H1

Around a third of the country’s total exports go to China (it accounted for 80% of export growth during 2013-14), a level of dependency on one market not seen since the 1970’s when Japan was the main export destination and before that the UK up to the mid-50s.

Sentiment regarding AUD is therefore very much tied to China’s fortunes and even acts as a China proxy for currency traders (the continuing liberalisation of CNY by China may in time weaken AUD as a China proxy).

Meanwhile, China’s GDP growth is at its slowest in 25 years falling to 6.9% last year from 7.3% in 2014. For this year, the IMF is forecasting 6.3%. Ongoing news of weakening industrial production and electricity demand, stock market volatility and periodic wobbles in CNY will continue to unnerve markets.

But there are some bright points for AUD, which should come to the fore later in the year. Unless, the global situation deteriorates substantially or the Fed raises rates aggressively, then AUD/USD might be nearing the end of its rout, which started in April 2013 when it stood at 1.0543 and it could bottom out somewhere around 0.6000-0.6500.

That would likely mirror the levelling out of the prices of many leading commodity groups, which could happen this year. Many are now trading at prices that are below their cost of production – a situation that is ultimately unsustainable and investment in new capacity is rapidly being cut.

And with a very low debt to GDP ratio of around 25%, Australia has spare fiscal capacity to support its economy, though households are heavily indebted. Also, China may yet indirectly lend a hand to AUD as more stimulus measures are expected by February.

Longer-term, China’s economy is definitely morphing towards a consumer driven one with the threshold having passed 50% recently and growth is strong (consumption makes up 60-70% of most developed economies). Though China’s days of mega-growth are over, it is now a very large economy with an ongoing requirement for all kinds of commodities. A consumer driven economy may shift the emphasis towards more demand for agricultural related commodities, semi-finished products, manufactures and services (education & tourism), which would still benefit Australia.

 
TECHNICAL ANALYSIS: AUD/USD – Outlook bearish

 

TECHNICAL ANALYSIS: AUD/USD – Outlook bearish

January has been brutal for AUD/USD and it looks like it will struggle to move back above the psychologically important level of 0.7000 in the short term. The low reached so far this year is 0.6837 with other support levels bunched around 0.6800 and 0.6758. Beyond that 0.6600 and 0.6500 are all possible targets in the coming months.

Resistance is placed at 0.6912, 0.6984 and 0.7049. Indeed, the 0.6900 level does seem to exercising a pull on AUD/USD for the time being. But further sell-offs in commodity and equity markets could see the pair move further downward.

Looking at the performance of AUD and various commodity ETFs it is clear that they are closely correlated in terms of direction. However, AUD/USD has fallen less dramatically – ~16% versus ~30% for many commodity ETFs over the last 12 months. Since early November, commodity prices have fallen to a much greater extent than AUD/USD.

Though, AUD does at least benefit from 2% interest rates to support it and Australia isn’t completely about, such is the size of the recent gap in performance that AUD may have some catching up to do with commodity prices on the downside.

 

By Justin Pugsley, Markets Analyst, MahiFX

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