the australian dollar tides turn 903142014

As 2014 comes to a close and many FX traders reflect on the year, the highlight for me throughout the last 12 months was US dollar strength, but in particular against a weak Japanese yen.

This time last year there was a buzz in the market about how far the yen weakness could truly go. Although the cross kept us waiting until well into Q3, the predictions from analysts (largely brought about through speculation on divergence in Central Bank policy) eventually came true and USD/JPY rallied well into 118 from a February low of 100.76.

Another talk of the town this year has been the Australian dollar. After being the second best G10 currency performer in 2014, the tides are set to turn for the local unit.

Why will it head lower in 2015?

Although long US dollar looks somewhat crowded, there are opportunities to take advantage of further moves in the greenback. These opportunities lay in exposure to the commodity currencies, but in particular the Australian dollar.

Here’s why:

The RBA

Jawboning the local until a suitable fair value should continue well into 2015. In all likelihood, the RBA will attempt to call the unit lower, even if it falls bellows 80 cents. Many analysts are now calling for a rate cut in H1, and credit market traders already price in a strong possibility of this happening (80% chance). These analysts cite an easing housing market and investor activity for the change in outlook on rates.

China

Global growth should start to accelerate in 2015. While the US, UK and Eurozone should start to make positive strides towards recovery, China will be the exception. The potential for Chinese growth to fall below 7% is a worry to many FX traders. The PBOC has already surprised market players by announcing easing for the first time in two years, in an attempt to curb this downturn.  Low inflation, weak credit growth and falling house prices will all start to weigh on the economy. As Australia’s biggest trading partner, this will inevitably dampen demand and drag the Australian dollar lower.

Commodity markets (Iron ore)

Terms of trade will be all important heading into 2015. The Iron ore price has struggled in 2014, trading at a five-year low and breaking $70. Demand should continue to contract and supply should increase further, resulting in predictions on the price to fall below $60 in the near-term.

The carry trade

Volatility in FX markets has made the carry trade a favourite among many. As the Fed begins to hike rates in 2015, the attraction of this trade will diminish significantly. The divergence in Central Bank policy will become more and more apparent as the US recovery gains speed.

Technicals

The trend line from 2009 highlights initial support at 8420 but the break below 8650 was a significant one. Analysts look to 79-8050 area for long term support.

Local Australian economy

Outlook for the local economy remains weak. Employment, real wage growth and domestic spending are all likely to remain under pressure in 2015. This will be helped along by a tighter fiscal budget.

With these catalysts for a lower Australian dollar mounting, entry levels look good below the near term support of 8420.