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The Australian dollar has led major currencies against the greenback in March but there are signs it might be "getting a bit ahead of itself", making it among the most vulnerable to a reversal in sentiment. It surged nearly 7 percent in its biggest monthly gain in more than four years to above 76 US cents. Its trade weighted index (TWI) is up over 3 percent, for its sharpest rise since 2012. The index last stood at 64.0.
In contrast, sterling, the Canadian and New Zealand dollars staged less remarkable rallies of 3 percent to 4 percent against their US counterpart. The Aussie's eye-catching rise is a reflection of a retreating greenback, upbeat economic fundamentals at home and a rebound in commodities like iron ore - Australia's single most valuable export.
Even currency speculators, who were overwhelmingly bearish on the currency from late 2014, have had a change of heart and started running net long positions since mid-February, figures from the Commodity Futures Trading Commission showed. "The news flow for the Australian dollar turned positive at a time when short positions were quite large," said Shane Oliver, head of investment strategy at AMP Capital. "We've seen short covering and now we're pushing towards the other extreme where shorts are turning into longs and people are talking about the Aussie dollar heading towards 80 cents." Yet this positioning also means the Aussie is especially vulnerable to a counter-punch, said Oliver, who expects the currency to fall towards 60 US cents over the next 12 months. Ian Pizer, portfolio manager for Aviva Investors' multi-strategy target return fund and target income fund, says shorting the Aussie against the dollar is his favourite trade.
Even if the Fed goes easy on tightening, there are reasons for the Australian central bank to keep the Aussie weak, he says. Indeed, the Australian central bank is under increasing pressure after Federal Reserve Chair Janet Yellen took a particularly dovish stance that triggered a broad selloff in the US dollar.
The market response to Yellen's comments and the rally in the Aussie would have irked the Reserve Bank of Australia (RBA). "Almost every central bank would like a lower currency, some say that openly and some don't actually articulate it," RBA Deputy Governor Philip Lowe said this month. "Like everyone, we would welcome a slightly lower exchange rate that would help in the rebalancing of the economy."
Governor Glenn Stevens last week also chimed in, saying the currency "might be getting a bit ahead of itself." Should the Aussie climb above $0.80 then the RBA may have to ramp up its rhetoric, said Paul Dales, chief Australia & New Zealand economist at Capital Economics. "Or seriously consider whether it needs to cut interest rates further to prevent it from being on the losing side of a currency war," Dales said.
The Bank of Japan and European Central Bank have both adopted negative rates to drive their currencies lower and bolster their economies. That leaves Australian rates of 2 percent looking astronomical in global terms, an unwanted attraction the RBA could well offset by easing in the next month or two.

Copyright Reuters, 2016

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