There is little doubt that the Australian dollar is the top carry currency amongst the majors and that it will likely maintain a yield advantage for some time. However, current conditions are often not as important to the markets as what the future may hold. Speculation has a constant, overwhelming and difficult to quantify influence over price action; and its ambiguity only intensifies when the currency is at an extreme on the yield and risk curves. For the Aussie dollar, the currency has relatively little to gain from its own fundamental trajectory; but it has everything to lose should the situation turn unfavorable. From the currency itself, nearly everything is turning out to support further appreciation. An economic recovery has taken root and stability in establishing itself in the more important sectors: consumer spending, investor lending and exports. Moreover, just this past week, we have seen job growth maintain its positive trend, business confidence rise, consumer sentiment turn positive and the RBA Quarterly Bulletin offer bullish projections. In the week ahead, the focus will turn on the home building in the fourth quarter, industrial trends for the first quarter and a broad index on growth forecast. Yet, speculators are more concerned with what influence this economic activity will have on interest rates. The central bank has already hiked the benchmark rate four times since the economy recovered from its slump. Governor Glenn Stevens has suggested that a ‘normal’ rate is still 75 basis points higher and the market is actually pricing a cumulative 116 basis points worth of tightening over the coming 12 months. However, as is the case with every currency, the Australian dollar does not derive its value in a vacuum. Its price is relative and determined through a comparison to the growth and return potential of its peers. From this standpoint, we may actually see the currency lose fundamental ground. For rates, the 116 basis points has already been largely priced into the market; and there is little chance that the central bank will grow even more hawkish and force a very extraordinary pace of tightening when the global economy is still nursing along its recovery. On the other hand, other policy groups have seen relatively nonexistent speculation of stimulus withdrawal until recently. Now, Credit Suisse overnight index swaps show greater potential for hikes from both the BoC and RBNZ over the coming year. Furthermore, the Fed, ECB, BoE and even the SNB have notably climbed. This eats away one of the most remarkable advantages this currency has maintained. All the points discussed until this point are long-term considerations; but they will play out constantly. Another more volatile and unpredictable driver is risk appetite. While it may be a struggle to keep its place at the top of the group in terms of risk, a plunge in sentiment will still find this one of the most vulnerable currencies. On the other hand, with a stable growth backdrop and considerable return to offset risk, it may take a deeper plunge than would otherwise be necessary to really force the Aussie dollar lower. On the other hand, should a specific drive for the nation’s health (like China throwing the breaks on its economy and markets), we could see a key pillar of support give way. - JK

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