The Aussie Dollar Just had its First Setback in Over Two Years

Joined : 30 Mar 2008 Posts : 34 Location : New York

Good Day Currency Traders!

Well, I knew this day would eventually come. Even the best currencies on earth will eventually chip away at their own fundamentals by how well they perform.

Now what does that mean? Well, when a country does well economically, inflation goes up along with it. In order to keep inflation from rising too quickly, central bankers have to raise rates.

As rates go up in an economically sound country, trader's money flows towards that country. In other words, currency investors invest in that country's currency, because it appears to pose little risk while offering a great return. So money floods into the currency and drives the currency's value higher over time.

How a Top-Performing Currency Gets
Knocked Off Its Pedestal

As this happened, the Australian dollar vs. U.S. dollar (AUD/USD) exchange rate has gone through the roof over the past year, and so have Australia's interest rates. After a while, that combination of high interest rates and a high exchange rate can put a lot of "wear and tear" on the economy. And that's exactly what's happening in Australia.

Up until now, the Aussie economy has been unstoppable. Even the U.S. slowdown hasn't affected it nearly as much as most major economies. Australia has held its own, mainly because the continued demand from China has largely overridden the effect of the U.S. slowdown.

That's why the Aussie dollar has prospered so much over the past year. Traders could run to the Aussie dollar and "hide" from the sub-prime fallout. Plus, they earned a high degree of interest (7.25%) while doing so. That looks extremely attractive compared to the shaky U.S. 2.0%. So it was a no-brainer until now.

First Chink in the Armor - Australia's Economy Loses Jobs for the First Time Since Oct. 2006

So what's changing? In one word: Employment. Australia has created jobs every month since October 2006. They managed to add jobs every month during the worst of the global slow down, credit crunch, and the sub-prime crisis mess. Now that's impressive.

So while one month isn't a trend for sure, just the fact that there were job losses may discourage the Aussie central bank from raising rates further.

After all, the economists were expecting Australia to create another 13,500 jobs this past month. Instead, they actually lost 19,700 jobs. That's a huge difference.

Now if this were the only downside to the AUD/USD pair, then that would be one thing. However, there's more to consider on the U.S. dollar side of the pairing also.
The Buck Has a Part to Play in the
Aussie Coming Down Too!

The buck has been strengthening this week. It appears that the "big money" is taking the U.S. seriously in its latest round of jawboning. Why? Well two Fed officials now have talked about "fighting inflation" and the possibility of rate hikes in the United States. As you know, one of those officials was none other than Ben Bernanke.

Then, Treasury Secretary Paulson said he supported a strong dollar and that he wouldn't rule out the tool of intervention. Now, we've heard about Paulson's "strong dollar" policies a million times but that last part is what got the market's attention.

Then even the President reaffirmed the support behind the dollar as well.

If any of these guys, especially Bernanke or Paulson are serious, then there's good reason to stop shorting the dollar. You have to assume they aren't bluffing, just in case. And I don't know too many traders that want to call that bluff and find out the hard way.

So in short, there's a lot of fundamental snags out there right now in favor of the dollar and one important factor against the Aussie dollar.

Aussie's Fundamental "Chink" Causes a
Technical Breakdown!

This has caused the first breach of the AUD/USD's long term trend line in about a year. So now we have not only a fundamental chink in the armor but also the technicians out there are noting this as well.

And if it turns out the fundamentals really are shifting, then that break down of the uptrend line really could hold. We'll find out shortly.

In the meantime, I'd be leery of being long the AUD/USD. Believe me that is probably the first time in over a year that I've gotten bearish on this pair. I've been an AUD/USD bull for a long time and rightfully so.

However, you have to read the handwriting on the wall and stay open and always re-evaluate your position.

Rather than turning around and shorting the AUD/USD, I'd rather short a currency with more flawed fundamentals at the moment. So if I were looking for a currency to short, that would be the New Zealand dollar (NZD/USD).