October Forecast - AUD USD

By FX Empire Analyst - James Hyerczyk
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The AUD USD finished the month of September with a close under 1.00 on a monthly basis for the first time since the January 31, 2011 close at .9973. Not only was this a weak close, but the currency pair is also trading below last year’s close at 1.0237. This suggests that a great shift in investor sentiment may be taking place.

The dramatic shift in investor sentiment from “risk on” to “risk off” was one of the driving forces behind the rapid sell-off in the Australian Dollar during September. Investors shed risky equities and commodities throughout the month for safety and liquidity, leading to a huge rise in the U.S. Dollar against the commodity-linked currencies. Risk appetite clearly shifted against the Aussie because of the lingering European Union debt crisis and continued talk that the deteriorating outlook for the global economy would lead to a recessionary environment.

This trend is likely to continue throughout October if the same events unfold the way they did in September. If the European finance ministers can gain control of their situation or at least convince the risk-taking world that they are making progress, then the AUD USD may see a relief rally. Expectations are not for a full recovery, but maybe a reasonable retracement of the sell-off from 1.1080 to .9387.

Besides the deterioration in demand for risky assets, the Aussie is also suffering from new talk from the Reserve Bank of Australia that rate cuts may be in the offing sooner than later. The RBA has changed its forecast for interest rates, hinting at one, maybe two rate cuts by the end of the year. If anything, continuing to spew negative rhetoric about interest rates means uncertainty and that may be enough to keep the pressure on the Australian Dollar.

One of the primary drivers of the almost yearlong rally in the AUD USD was the interest rate differential. The attractive high rates inAustraliacreated high demand for Aussie Dollars by investors given the historically low yields in theU.S.Interest-rate demand is expected to fade as the interest rate differential tightens. Based on this scenario, it is likely the AUD USD reached a significant top earlier in the year. In fact, if the year had ended on September 30, the Aussie would have posted a very bearish yearly closing price reversal top.

During October traders should expect the AUD USD to track the movement of the equity indices. There are just too many examples of the Aussie Dollar moving almost lock-step with the S&P 500 to ignore their strong correlation. Additional weakness is also expected to come from the possibility of aggressive interest rate cuts by the RBA. Lately just mere talk of a rate cut has hurt prices. As the central bank receives signs of a deteriorating economy, look for it to act accordingly and cut its benchmark rate at least once this year.

Now that the RBA is no longer in the mood to tighten, the reason to be aggressively long the Aussie Dollar has softened. Based on its current price level, it appears that traders are pricing in a 150 basis point cut over the next year. Combining this with the problems inEuropeand the possibility of another global recession, the RBA would be amiss if it thought that it had enough reasons to hold interest rates at current levels.

In summary, there is enough evidence at this time to suggest that a major top has been formed in the AUD USD. From a technical perspective, the Australian/U.S. Dollar is in a position to post a yearly closing price reversal top. This is most often a strong sign of heavy liquidation and selling pressure.

Volatility is expected to continue during October especially because of the Aussie Dollar’s strong ties to falling commodity prices and plunging equity values. In addition, a softer economy is expected to lead to a series of interest rate cuts by the Reserve Bank ofAustralia. With the incentive to chase these high yields being lifted, demand for the currency is expected to fall, leading to lower prices. While it is difficult to sell the AUD USD this far from the top, traders are encouraged to wait for a reasonable retracement of the current break before considering the short-side.

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