GDP, Central Bank Statement to Fuel Aussie Gains

NEW YORK ( TheStreet) --The Australian dollar has been one of the worst-performing developed market currencies this year. But improved GDP data and changing expectations in central bank policy indicate that we have probably reached a bottom in the Aussie downtrend.

This week, a series of important monetary policy meetings is taking place. One of the first on schedule was at the Reserve Bank of Australia. Given the increasingly dovish narrative that has been expressed by the RBA in recent meetings, large sections of the market were caught off-guard after the meeting came to its conclusion.

No changes in interest rates were seen but most of the language in the accompanying statement has been viewed as non-committal, which is a deviation from the views that have been expressed by the RBA in the last few months.

This essentially suggests the RBA believes there is no immediate need to ease policy after cutting interest rates to historic lows (to 2.5%) at its August meeting. The Australian dollar saw a surge in buying activity in the following sessions because investors will now have to reposition themselves for a potential bull run in a currency that is cheap relative to monthly averages and still attractive from a yield standpoint when compared to its developed-world counterparts. Australian bond yields have also risen to their highest levels since early July, a reflection of changing rate expectations for the country.

Carry Trades, GDP Data

The high interest rates tied to the Australian dollar make it an excellent candidate for carry-trade scenarios, where low-yielding currencies like the Japanese yen are use to fund purchases in higher-yielding alternatives (like the Australian and New Zealand dollars). Carry trades tend to perform better in more stable economic environments, and when we look at this year's performance in developed nations it becomes clear that these types of trades are likely to perform well in 2014.

At this stage, the real question is whether or not this changing policy stance agrees with the fundamental data. On the downside, the Australian economy has been forced to adjust to declines in mining investment, lower raw materials exports, and weakening retail sales data. More broadly, however, recent releases have shown the economy is not in such bad shape relative to previous expectations.

This week we saw that second-quarter GDP expanded at a rate higher than market estimates, with growth of 2.6% measured annually. The improved number helps to reinforce the RBA's position, suggests sector declines have had a limited impact and makes it less likely we will see another cut in interest rates before the end of the year.

Typically, the Australian dollar trades in ways that are highly sensitive to broader risk sentiment present in the market. Investors looking to take a position in the currency will have to consider negative external factors, such as shaky demand for raw materials in China, or the possibility of stimulus tapering in the U.S.

But with the domestic economy showing sustainable growth, and the global recovery progressing favorably in both the U.S. and the eurozone, the Australian dollar offers an excellent risk-to-reward framework given its cheaper valuations and improving fundamental backdrop.

In the near term, the currency remains vulnerable to increased volatility after this week's critical Non Farm Payrolls release in the U.S. and Australia's general elections next Saturday. These trends will likely carry over into the aftermath of the Federal Reserve bond "tapering" decision and the next round of debt discussions in the U.S. Congress.

But the overall impact from these external effects will be short-lived, and the Australian dollar is starting to look like an excellent value from a longer term perspective.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Cox is based in China, and has lectured at several universities there on international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of Web sites, including MarketBulls.net, Seeking Alpha, FX Street and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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