Parity could hardly be closer: at 99.68 US cents, the A$ is almost there. After starting the year in the high 80s, the “Aussie” has embarked on a volatile upward trend that has it poised to achieve a 1:1 exchange rate with the greenback for the first time in 28 years as a freely-floated currency.
Will it stop at parity?
“There’s a very strong fundamental trend that we’re seeing in the $A that will be difficult to reverse anytime soon, unless we see a major change in policies of the major central banks around the world,” says Kathy Lien, director of currency research at Global Forex Trading (GFT).
“The reason why investors are buying the Aussie in size is because of its stable economy, healthy economic outlook and correlation with commodity – particularly gold – prices,” says Lien. “But currencies are always expressed in a pair, and on the other side of the A$/US$ cross is a currency that no-one wants: the greenback.”
With US interest rates at virtually zero, the rate differential between Australia and the US stands at almost 4.5 per cent, making the long-Aussie trade a no-brainer, says Lien. “As long as the Reserve Bank of Australia is still planning to raise interest rates, and the Federal Reserve is thinking about increasing monetary stimulus, the $A is not only going to touch parity, it is probably going to exceed it – as much due to the strong downward pressure on the US currency as to Australia’s strong commodity exports position.”
Lien also sees the A$ continuing its rise against the euro and sterling. “Likewise, I think it’s going to push higher there, too, for much the same reasons. We haven’t seen a dramatic rally in the Aussie in terms of euro and in sterling that the currency has had against the US$, so there is actually more room for the Aussie to push higher against those currencies. If you look at euro/$A in particular, right now it’s trading at €1.41, and I think that there’s a good chance that we could see that currency pair move down to €1.38-1.39 – probably another 2.5 per cent rally in the $A against the euro. In the pound it’s a similar case to the US$, but not to the same degree, probably closer to 1.5-2 per cent,” says Lien.
When the Aussie’s purchasing power is viewed against the purchasing power of other currencies, it looks “extremely overvalued,” she says. “At an exchange rate of US98¢, the Aussie is approximately 30 per cent overvalued against the US$. But the Aussie is overvalued against every major currency including the pound, yen, euro and NZ$, and that hasn’t seemed to worry it.
“I do see the A$ getting to parity and beyond it, because these trends don’t turn around quickly, but I do see the Aussie going back to more normal levels. I don’t agree with some of the predictions that are around the markets, I don’t expect anything like $1.15-$1.20, I think it’s more likely to top out at $1.02. But that is still a pretty significant gain,” she says.
Lien says GFT’s trader client base is mainly moving into the A$ through spot forex and $A CFDs, as well as $A interest-rate CFDs. “We’re seeing a lot of interest in the 30-day Australian interbank overnight cash contract: that’s 100 minus the implied interest rate, the instrument is quoted at 95.49. People taking this trade are betting on interest rates rising, in fact they are selling this instrument,” she says.
Jonathan Barratt, managing director of FX and commodities broker Commodity Broking Services, says most of his clients are “long the Aussie” via margin FX, and futures. “It has been a trend that has basically been pretty unforgiving to be on the wrong side of. Clients are basically saying it’s a good trending market, let’s get long, and the best way in is through leverage.”
The margin FX market offers leverage ranging as high as 100 to 1, depending on the client and on “who is providing the line,” says Barratt. “The cowboys like 100 to 1, however they get dusted. To be conservative, we would say a $100,000 trade – that is, buying A$100,000 worth of US$ – would need a margin of 3 per cent, or $3000. That’s where a professional would trade from.”
With a conservative margin like 3 per cent, Barratt says traders are happy to control the position: although if they do want to put in place guaranteed stop-loss levels, the FX market is liquid enough to ensure that they get stopped out. “From that perspective it’s not too bad,” he says. “Once again it comes down to people understanding the level of risk they’ve got.”
Chris Weston, institutional dealer at IG Markets, says most CFD clients have been going long A$ against the US$. “Most of what I’m seeing is very much on the long side, the expression from my clients is that once it broke through 98.5 we’ll see it sucked to parity. There have been some calls that the run has been a little bit over-extended, and perhaps we’ll see some consolidation in the short term, but I think that most people have been waiting for the breakthrough, the institutional guys generally sell into that, and then it’s the second leg-up where they’ll look to get back in.”
With traders seeing no volatility in shares, they are looking to go where the strong trends are, says Weston. “That’s clearly happening in the currencies and gold. It’s been interesting to see people holding positions a bit longer, which they’ve been doing in that long-A$ trade.
“Most people would usually hold a CFD position for a day or two, but people have been holding for five days to a week, which shows you that they have confidence in the trend. They’ve been trading their stop-losses up and doing quite well – moving it in line with what’s going on in the Aussie,” he says.
Traders will continue riding the $A higher, but they will be looking to see a point where potential sellers might come in, adds Weston. “Parity really isn’t anything more than a psychological barrier: perhaps there’ll be people looking to take profits before it goes through there, and then look to ride the breakthrough when it goes through there again, but generally speaking, I think most clients see the ‘perfect storm’ for the A$ to go through parity.”
Quite simply, says Weston, there is “an awful lot of quantitative easing” priced in to the $US at present. “People are still happy to go long the A$ at the moment, but perhaps in November when it looks like the Fed will announce QE2 (the second round of quantitative easing), perhaps that’s going to be the catalyst for some US$ appreciation, because it’s going to be a case of ‘buy the rumour, sell the fact.’ That’s potentially going to be the trigger point for people closing out those long A$ positions,” he says.