MARKETS SPECTATOR: Dollar dive

Despite interest rate cuts of 1.5 per cent, the Australian dollar has been stubbornly resilient over the last year as never seen before forces keep the traditional ‘commodity' currency at lofty heights.

Capping further upside in the dollar, we have the Reserve Bank cutting domestic interest rates to counter the slowdown in the mining sector and subsequent pullback in capital expenditure. However, limiting the downside is the relative safe haven attraction of Australia's AAA-rated government bonds, which have been in hot demand given the number of rating cuts and huge yield difference between Australian and overseas interest rates.

In one of the most bearish calls I've seen, Morgan Stanley has put a sell recommendation on the Australian dollar, with a 90 cent target by the end next year.

"Among the most favoured investments were Australian government bonds, given the country's relatively high yields and pristine AAA rating. Indeed, foreign participation in the Australian government bond market, after averaging 30 per cent in the two decades up to 2005, currently sits near 75 per cent,” Morgan Stanley said.


Source: Bloomberg, Macquarie Research

However, looking forward the broker sees a large scope for these inflows to reverse as growth continues to weaken domestically and interest rates continue to slide. It sees Australia's terms of trade topping out and declining as Asian economies – which our exports rely on so heavily – shift their fast-growing economies towards more domestic demand based growth as opposed to export-oriented growth.

Morgan Stanley also notes that supply growth among commodities, especially iron ore, will continue to rise at a rapid pace, placing downward pressures on pricing.

"As Australia's terms of trade decline, this should prompt a fall in corporate profits and, subsequently, a drop in capital expenditures, employment, wages and aggregate demand – which should then feed through to lower inflation and further rate cuts,” in our view.

"As growth and rate differentials play against Australia, foreign investors are likely to rethink their safe-haven positions, driving a decline in the currency”, it believes.



Source: IG Markets

The above daily chart of the AUD/USD clearly shows signs of significant selling pressure. Since mid-September, the downtrend resistance line shows that price peaks have been trending lower. This in combination with the orange circles, which mark sessions where there has been a significant rejection of higher prices, indicates the
sellers have the upper hand around and above the 1.04 level.

Having said that, there is still significant buying on dips towards the major support level labelled, as well as around the 1.03 mark. Until these levels break decisively, it's likely to remain range bound, trapped between the 1.01 – 1.04 levels.