As we head into a new month and a big data week for the markets, I've outlined some thoughts on what some of the news events could mean for the Aussie Dollar and how this relates to the technical outlook.
The Aussie remains within the long term triangle formation dating from October 2011.
My view is that unless there's clear break of the triangle resistance, the most likely scenario for the Aussie is a decline to test the blue support line. This would see a move down to around 97.5/98c
The stochastic oscillator recently rolled over (see arrow) and is again heading lower. So a breach of near term support on the daily chart could be consistent with the stochastic resuming its decline to the oversold zone and price resuming its descent to the triangle support.
The recent rally in the Aussie has formed a trend channel. This is shown in green on the chart. The bottom of this channel is now close to the 200 day moving average. Together these form a support zone so a break below this level could set up for the downtrend to continue towards the triangle support around .975
The alternative is that we rally to again test the channel resistance. This could see a small break of the blue triangle resistance line and potentially a classic false break.
One approach to this would be to use the channel resistance for a good risk: reward set up, selling the break of the more obvious triangle line with a stop above the channel and positioning for a large decline back into the body of the triangle.
The 2 most watched developments in the US are likely to be the ongoing negotiations over the government budget (the Fiscal Cliff) and Friday's Non Farm Payrolls data.
Recent employment figures in the US indicate moderate GDP growth next year as long as the drag from government debt reduction is not too great.
Monthly jobs growth has averaged 170,000 over the past 3 months. However, Hurricane Sandy could make Friday's number difficult to interpret. Analysts are generally looking for jobs growth of around 90,000. This assumes temporary job losses of 150,000 due to Hurricane Sandy but a positive impact from this year's early Thanksgiving. Given the uncertainty caused by the large temporary factors at play, the market may be fairly unmoved by Friday's NFP number unless its a long way outside expectations.
Since mid November there has been a broad global "risk on" rally as markets have positioned for the expectation of a reasonable outcome in Fiscal Cliff negotiations. .
There's a good case to say that this current rally is getting close to a short term peak. Fiscal cliff negotiations look like taking at least several more weeks with the potential for market nervousness as each side stakes out a public bargaining position.
More importantly it seems to me that there is potential for a "buy the rumour, sell the fact" scenario when the result is finally negotiated. As with the recent approval of Greece's financing, the markets may appear underwhelmed by the positive result when it finally arrives.
This is because even with a good "Cliff" outcome, investors will be confronted with the reality of ongoing fiscal drag. In 2012, Government activity looks like representing a "drag" of about 0.9% on economic growth. So the best case scenario of a negotiated tax increase/spending reduction package with a drag of 1.5-2% of GDP would see the government slowing growth by an extra 0.5 to 1% in 2013. This makes it hard to be confident that the US economy will grow much more than 2.5% next year even with the benefit of the improved housing sector and Fed stimulous.
Aussie Dollar and the "Risk on Trade"
Something else that interests me about the Aussie Dollar is that it has recently underperformed the broad "risk on" move.
This is demonstrated in the chart below which compares the Aussie Dollar and the S&P 500 over the past 6 months. The correlation between these 2 markets has been high over the past 4 years (generally above 70%). They have tended to move in the same direction driven by the global market's broad risk on/risk off moves.
Looking at the chart above the recent underperformance of Aussie Dollar, has a lot to do with the fact that it didn't fall much after the US election and so hasn't rallied as the US stock market has recovered over the past 2 weeks.
But its also possible I think that the market is becoming a bit more negative about the Aussie Dollar as we get more news on the potential impact of the wind back in mining investment spending on our economy. Tomorrow's RBA meeting could provide some insight into how concerned the central bank itself is on this issue
There doesn't seem to have been anything in either the economic statistics or the financial markets over the past month to trigger a rate cut at tomorrow's meeting.
If the bank does cut rates tomorrow its decision is likely to be based on future concerns about the impact of reduced mining investment spending combined with Australia's fiscal drag. This was highlighted by last week's news of a substantial wind back in investment plans in the latest capital expenditure survey by the ABS and by RIO Tinto's announcement of plans to cut overheads by $5bn over the next 2 years
A rate cut tomorrow would not only narrow Australia's interest differential but may also heighten concerns about a weaker outlook for Australia. If that happens, I'll be watching the 1.029 support zone over the next few days