Markets Are Stalling in Anticipation of the Next Breakout Trend
Hope and optimism have spurred the markets to new highs over the past few months. Commodity prices have also jumped severely, a good sign that a global economic recovery of material proportion is in progress. Although global tensions have risen of late in the Arab world, the rush of capital to safe havens has been rather subdued, almost retarded. Yes, Gold has bounced back, but the rise was expected after a brief consolidation move. Markets now appear to be approaching a classic “stall” condition, where momentum builds somewhere in the shadows, only to breakout when least expected.
The forex markets are not immune to this stalling behavior either, even though the notion of “intrinsic” value does not exist. The world, however, has been waiting for the U.S. economy to come roaring back, accompanied by a strengthening Dollar, but this anticipation may have encountered some near-term resistance. One example worthy of study might be the “AUD USD” currency pair, decidedly a tale of two cities or countries, as it were. The 5-year chart below tells the unfolding story:
AUD/USD Currency Pair
Australia has been one developed Western country that has benefited enormously from the emerging market country phenomenon of the past few decades. China, India and many of their Asian brethren have prospered from years of off shoring activities employed by Western companies to cut costs and stay competitive. Manufacturing requires energy and raw materials, both in short supply in most Asian countries, except in the “land down under”.
Australians reside in a country known for its “expensive rocks”. Coal and iron ore are in abundance, and domestic mining interests are some of the best-capitalized firms in the industry and leaders in technology on the global front, as well. Government officials and mining interests have not always seen eye-to-eye, resulting in a few well-publicized skirmishes along the way, but Australia has rarely suffered from what is known as the “paradox of plenty” or the “resource curse” that has plagued many emerging markets.
Australia bypassed the recent economic recession that has befuddled nearly every other advanced economy on the planet. There is no real estate “bubble”, and interest rates have been raised gradually to curb inflationary tendencies, as one would expect. With a strong and stable economy, it is no wonder that the Australian Dollar has been on a long-term strengthening move over the past decade versus the greenback. Presently, the Aussie Dollar has been testing parity at $1.00. Forecasts related to future direction are mixed on a number of fronts. One group of analysts believes that $1.03 is achievable over the next twelve months, but a more pessimistic group believes a fall back to the $0.80 region is more probable. Barrier options may have a play shortly.
The Aussie Dollar is known as a “commodity” currency because its fate is so entwined with Australia’s export trade of coal and iron ore deposits. However, there is one more element that has impacted its value over the past five years, an investment practice known as the “carry trade”. One of the most popular forex strategies utilized by global banks and hedge funds is to borrow from a low-interest rate market, and then invest where the growth and return potentials are higher. Consequently, capital has flowed freely into Australia as a target country, with borrowings coming from the United States where interest rates had been depressed for some time.
When Lehman Brothers failed in 2008, it sent shockwaves around the world. Flights of capital to safe havens, typically U.S. Treasury Bills and precious metals, both denominated in “USD”, sent traders back to their trading desks to unwind carry trades and return Dollars that had been borrowed. The “decline” in the above chart was extreme, nearly 35%, when a similar decline in the Euro was closer to 20%, a lesser amount since carry trade volume was not a factor.
The Australian Dollar has recovered its lost ground, repeating its positively sloped trend of the past. As financial markets catch their collective breaths, all eyes are on Washington DC at the moment. Will lawmakers reel in the deficit without jeopardizing the mild recovery that has begun? Plan accordingly for opportunities that will surely come.
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