Current Rally in Australian Dollar Could Be at Risk

The Australian dollar (AUD) has been posting strong gains against the U.S. dollar (USD) so far this year amid improving risk sentiment and upbeat economic data, but the rally in the commodity currency could be at risk, ahead of Reserve Bank of Australia (RBA) meeting next week.

"The Australian dollar has been the second best G10 performer versus the USD so far this year. AUD/USD overnight hit its highest level since October 2011, at 1.0757, buoyed by higher-than-expected trade surplus data, positive Asian equities and M&A news," said a note from Societe Generale Cross Asset Research.

AUD performance has been underpinned by the U.S. Federal Reserve move to keep federal funds rate on hold for a longer period than previously indicated, besides upward surprise in the China's official January Purchasing Managers' Index (PMI) released Wednesday.

"Sentiment surrounding the AUD seems overwhelmingly positive. The currency enjoys high yield status due to having the highest key rates in the G10, better fundamentals and structurals than the eurozone or the U.S., and the higher-than expected Chinese PMI this week," said the note.

However, next key event for the AUD to continue its rally against the greenback will be the RBA's meeting Feb. 7, and the market expects a 25bp rate cut by the central bank.

"Among the 30 analysts interviewed by Bloomberg, only 3 anticipate no change, while 27 expect a 25bp rate cut. Note that the market's expectations are very pessimistic, with cuts of 95bps expected within a year. Nevertheless, next week's decision may be a close call after good news from China of late, as more than 75% of Australian exports go to Asia," said SG.

AUD could also come under downward pressure, if the recent improvement in risk sentiment fades and translates into risk aversion.

"We think investors would have to be very worried about the Asian (and global) economic outlook to question the bullish underlying uptrend in AUD/USD," said the note.

AUD/USD remains on the road to reaching its September 2011 highs at 1.0767 in the short term. The door would then be open for it to move towards the 2011 high of 1.1080. However, greater visibility on the euro debt crisis and financial stress, leading to more broad-based risk appetite, would be necessary for that scenario, SG said.