Australian Dollar Forecasts for December

AUDUSD Long-Term Technical Forecast

The AUDUSD spent all of November trading sideways. Still, a 5 wave drop from the top (.9856) is evident so a correction is underway. Initial resistance is the confluence of the former 4th wave and 38.2% of .9856-.6005; at .7256.

AUDUSD Fundamental Outlook/Interest Rate Forecast

The Australian Dollar - US Dollar interest rate differential is forecast to narrow substantially in the coming 12 months-adding further pressure on the previously high-flying Australian Dollar. Forex speculators had previously sent the AUD to multi-decade highs against its US namesake, as a strong interest rate advantage proved irresistible to highly leveraged investors. Yet the more recent wave of financial market deleveraging forced many traders to close long positions in the Australian Dollar and cover short positions in the comparatively low-yielding US Dollar. This dynamic explains the sometimes-violent declines in the AUD/USD during times of elevated financial market stress, and we expect said effects to continue driving Australian Dollar price action through the foreseeable future.

Interest rate traders predict that the Australian Dollar/US Dollar yield differential will fall by a further 216 basis points in the year ahead-a further bearish development for the Aussie dollar. If current financial market turmoil continues, we may see the previously high-flying Australian currency fall against its US counterpart.

Australian Dollar/US Dollar Valuation Forecast

AUDUSD Valuation Forecast: Bullish

The deep selloff that has seen the Australian Dollar punished along with other risky assets has overshot the mark, putting the Aussie in an undervalued position against the US dollar. Momentum is also in favor of AUDUSD upside: AUD was the best performing currency against the greenback last month, adding a healthy 4.24%. While the specter of further rate cuts certainly continues to hang over AUDUSD, recent comments from top RBA officials suggest they are favoring a "big bang" approach to easing (thereby avoiding entrenched rate cut expectations). On balance, the fundamentals may be aligning for a bullish leg in the Aussie.

What is Purchasing Power Parity?

One of the oldest and most basic fundamental approaches to determining the "fair" exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the "fair" EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.

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