Australian Dollar – How High Can it Fly?

It is another quiet morning for the U.S. dollar but investors are buying Australian dollars aggressively today, sending the currency to its strongest level in 4 months. From its 0.8660 low set in late January, the currency pair appreciated nearly 7% over the past 2 months. While slowing Chinese growth poses a major risk for Australia’s economy, the Reserve Bank’s decision to shift from an easing to neutral monetary policy bias kicked off the rally in AUD in early February. Since then, signs of improvement in the domestic economy reinforced the central bank’s brighter outlook, giving investors strong reasons to unwind their short positions.

The latest surge in the currency was driven by last night’s comments from RBA Governor Stevens. It was not so much what he said but what he didn’t say that sent the currency pair to year to date highs. Having previously expressed a desire to see the AUD/USD closer to 85 cents, Stevens refused to talk down the currency and in fact didn’t overtly mention their discomfort with the level of exchange rate even though it is 7 cents higher than where they would have liked to see it back in December. Even when pressed by a reporter on whether 90 cents is a “line in the sand,” Stevens refused to lock the central bank into an exchange rate target. While every policy making body would prefer a weaker currency in a low inflation, slow growth environment, in the case of Australia, they have become more tolerable of a stronger currency now that the economy is performing better. The RBA still expects the currency to move lower in the long run because of the terms of trade and the prospect of higher U.S. rates. However between their neutral monetary policy stance, improving data, speculation of stimulus from China and liquidation of short positions, investors will be happy to take the Australian dollar as high as 94/95 cents in the near term.

According to the most recent CFTC IMM report, speculative short positions were shaved by 35% as of last Tuesday. There’s no doubt that more short positions have been covered and we would not be surprised if positions are currently close to neutral. In other words, we don’t believe that a short squeeze will contribute much more to the AUD/USD rally. However there’s plenty of scope for fresh longs especially if China fast tracks stimulus.

From a technical perspective the inverse head and shoulders pattern in AUD/USD has been broken and the currency pair is trading above the 23.6% Fibonacci retracement of the 2011 and 2014 sell-off and the 200-day SMA. While there’s short-term resistance below 94 cents, there’s no major resistance until 0.9550. As U.S. rates normalize, the U.S. dollar will rise and commodity prices will fall, driving the Australian dollar back below 90 cents so while we expect further strength in the short term, parity is not a target for AUD as gains will be capped near 95.

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