The Australian dollar has been on a tear lately, trading at its highest levels since the currency was gloated in 1983. What happens next?
Fundamentally, the outlook for the Aussie is still pretty good, according to Rebecca Patterson, global head of currencies and commodities for J.P. Morgan's private bank.
"Australia’s natural-resource strength impacts the currency a few different ways," she wrote in a research note. "As hinted at above, higher commodity prices bring Australia greater trade revenues. In addition, however, Australia attracts capital flows tied to these resources: both foreign direct investment (M&A) and equity and bond inflows as foreign investors want to gain exposure to Australia’s commodities and commodity-related firms. According to Dealogic, Australian M&A volume rose by 59% to US$18.8 billion in Q1 2011 from the same time last year, with the number of deals rising 10% over the same period (mining-related deals dominated).
"Stronger Australian markets helps local confidence and in turn, the real economy. Better growth and rising inflation pressures then lead to tighter central bank policy. Now at 4.75%, the Reserve Bank of Australia (RBA) has been raising policy rates since October 2009. We believe rates will likely go higher still; our Investment Bank looks for 5.25% policy rates by December. Attractive - and rising - yields have been another reason foreign investors are putting capital to work in AUD-denominated assets.
"These capital inflows to Australia are critical, as they offset the country’s current-account deficit (estimated at 1.5% of GDP this year; JPMS LLC data) and keep the Australian dollar supported."
Patterson sees a couple of potential risks. "One risk to watch is the possibility of a new sovereign wealth fund (SWF) or stabilization fund that could that could funnel natural resource revenues to be invested for future needs (Russia and Norway, among other countries, have established similar funds)," she wrote. Also, bullish sentiment on Australia is very strong, and negative news could cause that mood to shift quickly, with a potentially dramatic impact on the Aussie dollar.
On a technical basis, Patterson wrote, "We see support for AUD/USD around 1.02 and 1.0155; below that, around parity. Looking higher, we see the next key AUD/USD resistance around 1.04 and then 1.05/1.0560."
Patterson's target for the Aussie dollar was $1.03 by year-end, which of course it has already reached. But she is still "constructive" on the currency, and will set new targets in the next several days.
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