Fundamental Forecast for Australian Dollar:Bearish

The Australian Dollar was the worst performing major currency on the week against the U.S. Dollar, falling by 3.10 percent. The Aussie’s underperformance comes as no surprise given deteriorating global sentiment rooted in Euro-zone follies; the negative outlook markets have collectively taken hasweighed on the higher yielding currencies and other risk-correlated assets, such as equity markets. Still, despite losing 7.89 percent against the U.S. Dollar in November already, there appears to be some more room to the downside, even though a corrective bounce can’t be ruled out of the question. The next target is the October 4 low, at 0.9388 – a level that should easily be achieved next week if nothing changes over the coming days.

Australian data has not been the catalyst for the currency’s decline; as hinted at earlier, it has been deteriorating global sentiment. This past week, although market conditions were notably ‘thinner’ given the major U.S. holiday, Euro-zone debt fears trumped any and all good news. Similarly, fears of a ‘hard’ Chinese landing flared again after data showed that Chinese manufacturing production had fallen to a 32-month low.

Furthermore, the tightening liquidity conditions evident in the financial markets have weighed on the Aussie, and this is expected to continue for some time. The Euribor-OIS 3-month spread, the rate at which Euro-zone banks lend unsecured funds to one another, is pushing highs unseen since 2009; in terms of the trend, the last time the Euribor-OIS 3-month spread was on the rise and was this elevated was the week after Lehman Brothers collapsed in September 2008. As a speculative investment vehicle – the Aussie offers a considerably higher yield than the other major currencies – it has and will face pressure as demand for liquid assets – mainly the U.S. Dollar – surge.

Looking ahead to the coming week, there’s not much to be said in terms of market moving data that could alter the Aussie’s downward trajectory; a major bounce will only be forecasted if the situation in Europe shows signs of modest improvement. The most important piece of data is due Friday, when housing market data is due. Building approvals are forecasted to have contracted by 14.4 percent in October from the same period in 2010, an ominous sign that the Australian housing bubble may be about to pop. Lower Chinese demand for Australian goods coupled with a deflating housing sector will accelerate the Aussie’s gains going forward.

With little reason to be bullish in the near-term, especially from the fundamental perspective, any bounces the AUD/USD experiences will likely be technical in nature. As such, until sustainable solutions are set forth in the Euro-zone,and as China continues to exhibit economic weakness,we remain bearish the Aussieacross the boardfor the indefinite future. –CV