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Dip in Aussie dollar offers tactical buying opportunity

The Australian dollar looks vulnerable after the country’s central bank cut interest rates and highlighted the risks associated with the eurozone crisis, but many investors are still prepared to bet on further gains for the commodity-linked currency.

The Aussie plunged on Tuesday after the Reserve Bank of Australia (RBA) cut rates by 25 basis points to 4.5 per cent, citing the deteriorating global growth outlook and signs of caution domestically outside of the country’s resource sector.

“The Australian cut marks an important turning point towards reconvergence of G10 monetary policy with US policy,” says Ray Farris, global head of FX strategy at Credit Suisse.

He expects the European Central Bank to follow suit and cut rates by the end of the year.

“This will likely limit the extent to which the dollar can weaken against the majors, barring significant new policy stimulus from the Federal Reserve,” adds Farris.

Traders said the market was partially, but not fully, positioned for the move from the RBA, which reflected a sharp turnaround in the fortunes of the Australian economy.

Earlier this year, the market was still positioned for further rate increases.

“The move further undermines carry and risk-on strategies, of which the Aussie has been one of the primary beneficiaries in the past couple of years,” says Michael Derks, chief strategist at FxPro.

“Clearly, Europe’s sovereign debt crisis is hurting Asia’s main exporters, which in turn will curtail demand for Australia’s resource exports.”

That view was underlined as Chinese manufacturing and export data came in weaker than expected.

The Aussie, which on Monday was sitting comfortably above $1.07 to the US dollar, dropped down through its 200-day moving average of $1.0405, which attracted selling interest from model funds and momentum accounts.

It fell as low as $1.0328 against the US dollar and dropped to Y80.75 against the yen, taking the Aussie dollar back to levels it was trading at before Japan’s Ministry of Finance intervened to weaken the yen on Monday.

But not all observers were convinced that weakness in the Australian dollar would last.

UBS remained bullish on the currency, raising its one-month forecast for the Australian dollar against its US counterpart to $1.04 from $0.95, and its three-month prediction to $0.97 from $0.90.

Chris Walker, an analyst at the investment bank, says that, fortunately for the Australian dollar, even after a 25bp cut, the RBA's policy rate would still stand head and shoulders above its G10 peers and Australian yields would still be generous enough to attract inflows.

“True, the currency's defences would be weakened, but the cost of carry would still be high enough to discourage excessive selling,” he says. “For this reason, we doubt that a 25bp cut alone will dramatically turn the tide against the Australian dollar.”

Todd Elmer, a strategist at Citigroup, said the weakness in the Aussie represented a tactical opportunity to buy the currency.

He said the rate cut did not reduce the underlying attractiveness of the Aussie.

“Interest rates are still among the highest in the developed world, Australia enjoys a strong fiscal position and it remains the deepest, most liquid market with tight links to Asia,” says Elmer.

“Commodity prices may have levelled off, but investment in Australia’s resources sector is likely to continue, which spells further inflow from abroad.”

Furthermore, Elmer adds that sovereign buying of the Aussie was likely to accelerate.

“Central banks upped their purchases of the Australian dollar and other small currencies after the peak of the global financial crisis in late 2008 and we believe this pattern will play out once more,” he says.

“If anything, buying from this source stands to be more intense, since credit woes in the US and Europe could see a marginal increase in inflows to other currencies.” 

 to be more intense, since credit woes in the US and Europe could see a marginal increase in inflows to other currencies.”

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