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Downward Bound Down Under?

Tuesday, 24 Jul 2012 | 3:48 PM ET
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The Australian dollar has been on a roll, but these strategists think the good times are going to stop.

Got yield?

The Australian dollar does, and that combined with a strong sovereign credit rating has helped propel it sharply higher over the last several weeks.

That's nice if you are long the Aussie, but Adarsh Sinha, a currency strategist at Bank of America, says the good times aren't likely to last long. In a note to clients, Sinha says he expects the Australian dollar to again move below parity with the U.S. dollar before the end of the year, thanks to "weaker global growth, including domestically and in China, with a central bank that is less accommodative of currency strength and external risks from Europe."

There are technical factors for Sinha's wariness as well. He notes that the euro is close to a record low against the Aussie dollar, and volatility for the pair is low as well. But if volatility picks up - as it could, if the situation in Europe continues to deteriorate - the appeal of the carry trade, where investors sell the euro against the higher-yielding Aussie, will diminish. Also, he argues that Asian central banks, which in recent years were adding to their reserves, particularly of the Aussie, are slowing their overall reserve expansion.

If that sounds ominous for the Aussie against the euro, Sinha argues that selling the Aussie against the U.S. dollar could be an even better trade. Implied volatility for that currency pair is where it was when market conditions were much more benign, he says.

"In our view, the downside risk premium for AUD/USD is too low, particularly if some of the flow support from carry traders and central banks, as discussed in this note, diminishes."

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