The Australian dollar rally is looking a 'little overdone'

ADRIAN DENNIS / AFP / Getty Images

The Australian dollar has been on a tear this year, jumping over 10% against the US dollar to the highest level in over two years.

A combination of a weaker greenback, stronger global risk appetite and improving fundamentals such as higher commodity prices and economic activity both at home and abroad has proven to be a potent mix.

Sitting just below US 80 cents today, the Aussie’s recent run higher has got many wondering whether it can continue, taking it back to the mid-80s or even higher in the period ahead.

While no one knows for sure, Daniel Been, head of FX strategy at ANZ Bank, thinks that the Aussie’s move is now looking a “little overdone”.

“The Australian dollar has now overshot fundamentals,” he says, pointing to the chart below.

Source: ANZ

“Since early 2015, the AUD has spent the majority of its time trading on the weaker side of fundamental fair value. The recent move higher has reversed that,” he says.

“The AUD is now four cents richer than its long-term relationship with rate differentials and commodity prices would suggest.”

And while some believe the Reserve Bank of Australia (RBA) may deliver a rate hike far sooner than what many currently think, potentially as soon as November this year, Been doesn’t think the RBA will oblige the Aussie dollar bulls.

“The RBA over the past couple of weeks highlights that the bank is not yet close to shifting its bias,” he says.

“While confidence in its current forecasts has grown, the bank continues to highlight that there is significant slack still present in the labour market.

“We think that the threshold to the RBA raising forecasts — a precondition to a real shift in bias — remains very high.”

And with domestic monetary policy settings unlikely to support any further gains, Been suggests other factors also present a near-term danger for the Aussie.

“On the USD front, our model suggests that the USD has now reverted back to fair value,” he says.

“Further, we do not think that political dynamics will justify a further decline in the USD, and we also think that pricing of the Fed and speculative positioning unwind have all tilted the risk reward for the US dollar higher.”

Essentially much of the bad news has already been priced into the greenback, adding to the risk of a reversal should the US data or political landscape improve.

Been also says that market liquidity is also providing warning signals that volatility may be about to increase, a scenario that tends to undermine the Aussie as investor appetite, and capital flows to riskier assets, declines.

As such, Been says that the Aussie will struggle to push much higher from here.

“We do not expect that fundamentals can push it any higher and think that global risk appetite now looks extended,” he says.

“The AUD is due for some consolidation.”

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