A Closer Look At the Aussie Dollar And Where It May Be Headed

Written by ForexTraders.com on July 28, 2010 at 12:08 PM ET

During the 2008 Global Credit Crisis, Central Banks around the world united in a concerted effort to stave off the next Great Depression, by slashing short-term interest rates to historically low levels. The quick and decisive action by global financial leaders worked, and in March of 2009 the recession bottomed out and a relatively strong recovery began to unfold in industrialized nations. As the recovery developed, Central Banks still left rates unchanged at historically low levels in order to provide further liquidity to credit and financial markets. Australia, however, did not. The Reserve Bank of Australia was the first Central Bank to begin tightening monetary policy in October 2009. The RBA had lowered rates to 3.0% during the height of the global crisis, and in October the RBA began a very aggressive tightening schedule that has taken the short-term cash rate target from its low of 3.0% to the current rate of 4.5%. This strong rise in the cash rate has also caused a nice rise in the Australian Dollar versus many currencies, including the low-yielding U.S. Dollar.

Investors seeking investment yield have been selling U.S. Dollars and buying the Aussie. These interest rate hikes by the RBA have caused the AUD/USD to appreciate over 1,000 pips in the last 3 months.

The current run up to the HI on Tuesday at 0.9068 was due to a possible rate hike by the RBA next week. Thus, the current rise in the Aussie over the last few weeks has been partly due to investors pricing in another interest rate hike from the RBA. Last month, the RBA left rates unchanged due to the economic turmoil in the EuroZone and a lack of inflationary pressure. At the end of their statement, they said that both of these situations would need to materially change in order to justify further rate hikes. The EuroZone Debt Crisis is under control. The Stress Tests have been released and the market has regarded them with cautious optimism, so that would be an indicator of a possible rate hike. The second key is inflationary pressure.

And this is where the case for an interest rate hike in August falls apart. Tuesday evening, Consumer Price Index came out far below expectations. The expected figure was 1.0%, but the actual release was only 0.6%. Consumer Price Index is a leading economic indicator that offers economists powerful clues concerning inflationary pressures. If prices are increasing too much each month, then inflation is a threat and interest rates may need to be raised in order to counteract this threat. Conversely, if prices are decreasing too much each month, then deflation may be a threat, and further monetary stimulus may need to be injected into the economy in the form of lower interest rates or other measures.

Thus, with CPI coming out quite lower than expected, it is clear that inflation is not currently a threat in Australia, and there is no need to raise interest rates at the moment. Let's take a look at a 5 Minute AUD/USD chart in order to get a clear picture of how important this data was to traders.

So, in the chart we can really see how traders sold the Aussie sharply on the release of the news. The move up that we saw in the first chart was largely due to investors pricing in future rate hikes out of the RBA, and when the CPI figure came out as low as it did, this put to rest the possibility of an RBA rate hike in the very near term, thus investors needed to sell all of the Aussie Dollars they had accumulated.

After the rate announcement, Bloomberg reported that there is now a 0% bet in the credit market of an interest rate hike tomorrow. So, what does this mean for the Aussie in the near term? It should continue to make a move lower until it finds buyer support. Let's examine another chart to see where that buyer support may be.

The current Daily candle that closed Tuesday is a bearish engulfing candle which confirms the downside risk that the CPI figure has brought into the market. As the Aussie moves lower, it should find strong support in the 0.8840-8850 level. This area, as you can see in the chart above, acted as strong resistance for several weeks before price was finally able to break through during this current leg up on the Daily Chart. As price now moves back down, it should find initial support in that area. A break below that area would show quite a bit of Aussie weakness. Further support is not really clear until we reach the last swing low on the Daily Chart, which is at 0.8633. A retest of this level will most likely not happen without further fundamental support to the downside.

The Reserve Bank of Australia is still expected to continue raising rates in 2010, so we should see further upward movement in this pair over the next 3-6 months. As the Aussie begins to move down, many investors and traders will be positioning themselves to build long positions in this currency pair.

Another Aussie pair that took a huge hit with the release of the CPI figure was the AUD/JPY. In the immediate aftermath of the news release Aussie Yen moved down 80 pips. This currency pair will most likely begin a corrective leg as well to the downside, which could open up further buying opportunities. The yield spread is expected to increase between the Aussie and the Yen throughout the rest of 2010 and 2011, so the long-term outlook for this pair is very bullish. A strong correction to the downside on this Aussie Yen may be a perfect time to begin building long positions in expectation of a resumption of the upward trend.