Australian dollar may be riding for a fall

The Australian dollar could be vulnerable to a setback that takes it back to parity against the US dollar in the next two months. The Australian currency has risen since June 1 and is still generally in favor among foreign exchange traders. For example, data from the US Commodity Futures Trading Commission shows speculative accounts added to their holdings of it in the week ending July 3. But while the Australian dollar remains backed by one of the highest official interest rates in the developed world, growing evidence of a global economic slowdown will chip away at demand for Australia's raw material exports and therefore its currency. For one thing, there are signs that China's appetite for Australian commodities, which has helped Australia's economic performance and its currency, might now be waning. Australian share prices were hit on Monday by a profit warning from mineral sands miner Iluka Resources which fanned fears about slowing global growth. The firm took a dim view of prospects in China. The Australian benchmark S&P/ASX 200 index fell again after disappointing Chinese trade data on Tuesday. That data raised concerns about the strength of domestic demand in the world's second biggest economy as imports grew at half the expected annual pace. The breakdown of the data showed imports from Australia fell to US$6.7 billion in June from US$8.2 billion in May. Other economies are in no position to take up the slack if Chinese demand for Australian exports falters. US growth is sluggish. For example, the data on Friday showed non-farm payrolls rose by 80,000 in June. That was the third consecutive month of jobs growth below 100,000 — a level which many economists deem to be the minimum pace of job creation consistent with self-sustaining US economic growth. Meanwhile, the euro zone continues to be beset by a crisis that is sucking in more and more of its members. The natural riposte from those who are long of Australian dollars is that the Australian economy is in better health than that of either the euro zone or the United States. They say the currency's high standing is therefore justified. There is also the argument that the Australian dollar will be supported by those central banks who are diversifying their reserves. Russia's central bank said in May it would start buying Australian dollars as part of its policy of reserve diversification and, on June 22, a source familiar with the matter said those purchases had begun. But central banks actively manage their reserves and, if circumstances change, adjustments will be made. Australian dollars can be sold as well as bought. There is also the issue of where these central banks will invest Australian dollar reserves and the interest earned. Australia's government funding agency has slashed its annual net bond issuance to A$9 billion in the financial year that began in July, from A$44 billion in the 2011/2012 financial year. This may temper diversification interest. The logic for staying long of Australian dollars has merit, but much of it is rooted in the past. When Australia's central bank kept rates at 3.5 percent on July 3, Gov. Glenn Stevens spoke of a "more subdued international outlook than was the case a few months ago." That could spell challenges for an economy which is so dependent on commodity exports to international markets. Factors which have supported the Australian economy's outperformance are shifting under the feet of a foreign exchange market that remains enamored with the Australian currency. This leaves those traders and investors who are long of Australian dollars vulnerable to a slide that could see the currency back at parity against its US counterpart. — Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own.