Jobs Reports, Chinese Data Support Aussie Outlook

The Australian Dollar has posted strong rallies this week, as Chinese economic data showed improvement and political agreements in the U.S. alleviated some of the market’s need to buy safe haven assets.  The CurrencyShares Australian Dollar Trust ETF (FXA) is trading at its highest levels in four months and the argument for broader weakness in the U.S. Dollar is supported by likely reluctance at the Federal Reserve to begin cutting back on quantitative easing programs.  These arguments have been based on the idea that the recent government shutdown (which led to nearly $25 billion in lost productivity) has put the U.S. economy in a more vulnerable position, and that the Fed will be wary of contributing to potential volatility in stock markets by announcing reductions in monthly stimulus purchases.

On a comparative basis, this puts ETFs that track the value of the U.S. Dollar in a less favorable light.  This week’s activity in the PowerShares DB US Dollar Index Bullish ETF (UUP) helps confirm this, with the ETF now dropping to its lowest levels in eight months.  Going forward, these bearish trends should be matched by the CurrencyShares Japanese Yen Trust ETF (FXY), which tracks the value of the Japanese Yen, as a global economy with fewer uncertainties and support from widespread central bank stimulus will likely re-ignite activity in carry trades.   The combination of these factors suggests continued weakness in assets denominated in both Dollars and Yen, as prolonged stimulus programs at both the Bank of Japan and Federal Reserve indicate increased money supply and the need to protect against slowing growth.

Factors Supporting the Australian Dollar

“Since ETFs like UUP and FXY have a multitude of negatives supporting sell positions,” said Haris Constantinou, currency analyst at TeleTrade, “it makes sense to start looking at higher yielding alternatives.”  Amongst the majors, the interest rates tied to the Australian currency (at 2.5%) stand head and shoulders above most of its developed-market counterparts.  But in addition to these yield incentives, the macro fundamental picture in Australia is supportive as well.  The country’s raw materials exports should show gains into the end of the year, as fears of a hard landing in China (Australia’s largest trading partner) have been reduced.

Third quarter growth in China managed to hold above the PBoC’s target rate, coming in at 7.8% and suggesting manufacturing activity in emerging markets will improve in the fourth quarter.  This is a strong improvement from the 7.5% growth that was seen in China during the second quarter.  This bodes well for fourth quarter demand expectations in Australian raw materials exports (such as copper), creating a supportive external backdrop for the country’s economy.

Internally, encouraging evidence can be found as well.  Australia’s unemployment rate showed a larger than expected drop in September, as the economy added 9,100 jobs for the month, and the national jobless dropped from 5.8% to 5.6%.  All of this suggests that the Reserve bank of Australia will be less likely to reduce interest rates before the end of the year, supporting the FXA ETF along with generalized assed denominated in Australian Dollars.