DY: Australian Dollar: Testing the Limits of Irrational Exuberance
The Australian Dollar refuses to be denied, with prices finishing last week just off another post-float record high above 1.05 to its US namesake. By any measure, the outlook is skewed decidedly against continued gains and has been so for some time, and yet the momentum behind the rally is impossible to dismiss. With that in mind, it appears equally ill-advised to chase current gains or bet against them, taking what little solace can be had from the familiar platitude, “the markets can remain irrational longer than we can remain solvent.”
The Aussie easily outperformed the majors in the aftermath of the Great Recession as investors’ appetite for returns return once again overwhelmed their taste for safety and sent capital chasing the highest interest rates in the G10 FX space. The RBA reinforced this dynamic when it became the first of the major central banks to raise borrowing costs in the aftermath of the meltdown, issuing the first of 150 basis points in tightening as early as October 2009. However, this is hardly a valid explanation for a continued advance considering this yield advantage is increasingly in peril as the RBA affirms a neutral posture (at least) for the remainder of this year while other central banks step up policy normalization efforts. Currency markets are famously forward-looking, and the prospect of narrowing yield spreads ought to send traders off for greener pastures where rates-driven rallies akin to the Aussie’s own have yet to materialize in earnest.
With that said, identifying the breaking point to the rally has proved both elusive and financially painful. Clearly, dovish RBA has proved insufficient. This puts the spotlight on overall sentiment trends, which would have brought the Aussie down along with the spectrum of risky assets were they to take account of just one of the numerous headwinds facing global growth (massive fiscal retrenchment, expiring monetary stimulus, crude oil prices close to $113/barrel, lingering uncertainty about the impact of the Tohoku disaster in Japan and worrying developments in Europe, just to name a few). Alas, optimism remains unshaken, misguided as that seems to be, and so the Australian currency stands unbowed. One can only suspect that when the turn does come, the bears will be rewarded handsomely considering the Aussie has become so deeply over-stretched to the upside that the snap-back will prove particularly sharp and painful. In the meantime, there seems little recourse but to wait.
