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Currency Forecast: AUD/USD Outlook

In contrast to many of the other majors, the Australian Dollar has held up very well in the face of the strong dollar rally that characterized the first half of this year. The strength has been a result of many reasons including a surprise interest rate hike by the Reserve Bank of Australia in March, keeping carry traders in, soaring commodity prices and long-term Chinese demand. Although rising commodity prices make Australian exports more expensive, unrelenting demand from industrializing nations, especially China , have kept the effects of this fairly low. The strength of the AUD has also given Australians the chance to buy cheaper goods from other countries and the consumers have embraced this opportunity. Yet despite what should be stronger corporate profits, the economy as a whole has not been performing fantastically. Although the current unemployment rate still stands at a 25-year low of 5.1%, growth in the labor market is definitely headed downwards. After 6 months of increase out of the latter 7 months in 2005, job ads declined 4 out of the last 5 months with the most recent one being an alarming -7.3%, the largest since April 2003. The effects can be seen as change in employment seems to have peaked in early 2005. After monthly gains upwards of 50,000 in the first quarter, April and May saw 19,900 and 14,000 jobs created respectively.

The labor market appears to be losing steam and the March 25bp interest rate hike has made its way to consumer spending. Retail sales fell in April, the first time in 2005, by 0.5%. The problems seem to stem from the skyrocketing growth that occurred in 2004. During this process, many capacity issues came up for firms. Although wage growth has been tame, slower labor productivity has pushed unit labor costs up and has made companies slightly wary about hiring although business confidence is up. Yet the sliver lining is that business investment is gradually improving. The push that the economy has experienced has managed to uncover many structural flaws, one of which is transport bottlenecks, which limited commodity exports recently. With low corporate debt levels and healthy business confidence, firms will have every means to bend to the needs of production capacity. In time, this will increase labor productivity and hiring could be on the rise again towards year-end and going into 2006. This means that although household spending will remain contained in the next few months, it won't stay that way for too long. To add to this argument, the recent government surpluses have made their way into the budget as tax cuts in both personal and business incomes.

Expect RBA To Keep Rates Unchanged
With a GDP slowdown in the works, the Reserve Bank of Australia will most likely put the brakes on any further monetary tightening for the year. The current rate of 5.50% should be enough to keep inflation within the 2-3% inflation target range kept by the central bank. In terms of consumer spending, the expected deceleration shouldn't put any pressures on inflation. The current level of the Australian dollar is also ensuring that import prices remain low. Any risks come from constraints on output growth. With the economy operating so close to capacity, demand, even if it is lowering, becomes relative. If companies just aren't able to churn out enough goods, prices will rise, as elementary economics dictates. However, assuming that these risks don't pan out, the current interest rate is sitting in the RBA's "neutral" long-term stability range of 5-6.25% and isn't likely to head anywhere in the near future. With the US ready to raise rates in the latter half of this year, the positive interest differential that the Australian dollar is enjoying will surely be eroded. The biggest risk to the upside would be a recovering in residential investment coming before it's expected. Meanwhile, the same upside risk for interest rates will be a downside risk to GDP. In a country so reliant on loans with the household debt at record levels, the effects from even a small increase in interest rates will certainly be widespread.

Watch Gold Prices
The fate of the Australian dollar is highly dependent on what lies ahead for gold prices. As the world's third largest producer of gold in 2004, just barely behind the US , the currency moves fairly in line with the commodity. Going into June, gold has pushed back up towards $440/oz again, making it the third peak this year. Some analysts find it quite likely that the precious metal will approach historical highs once again. If so, the AUD is likely to demonstrate a repeat of last year's activity.

Technical Outlook
The Australian dollar is a phenomenon compared to the other majors as the pair remains near multi year highs with the Aussie holding the trendline that dominated the price action since the middle of 2002. The previous six months have seen the pair confined to a trading range with .7500 acting as a strong resistance and .8000 confining the Australian dollar to a 500 pip range.

The psychologically important .8000 level is acting as a ceiling for Aussie bulls. The next six months might see interesting price action developing as the Australian dollar might try its luck and push the pair above the .8000 figure, thus breaking a multi year resistance. The breakout has a potential to turn into a new trend, which may take the pair all the way up to .8500 figure, a high the pair has not seen for over a decade. A break below the trendline on the other hand will most likely see a trend reversal in the pair with the Aussie relinquishing the control of the price action to the greenback.

Indicators point to range trading conditions with Stochastic rising above the oversold line. ATR is falling as range is beginning to shrink, a pre-breakout/breakdown setup. ADX (DMI) added to the range trading outlook with DI+ and DI- continually crossing each other, thus constantly issuing buy and sell signals, which is indicative of range trading.

Key Levels: The psychologically important .8000 level is acting as a ceiling for Aussie bulls. The next six months might see interesting price action developing as the Australian dollar might try its luck and push the pair above the .8000 figure, thus breaking a multi year resistance. Enlarge Chart View
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