It looks like the market down under will begin pricing-in the shift in policy stance by the Reserve Bank of Australia. Over the weekend The Sunday Telegraph revealed that the Big Four banks within the country will be hiking rates faster than that at which the RBA is raising them. That is, mortgage, credit card rates, etc will begin to rise as the central bank raises the costs of funds that the bank borrows. This could be very beneficial for the Australian Dollar. Not only will the overnight lending rate rise, but so will longer term 30-year mortgage ones. Global investors who are looking for attractive yield might shift more of their focus toward the country as a result. Let’s not forget that as market rates rise, the government has to also take measures to attract investors toward their debt. Since all of these assets are priced in Australian Dollars, the currency will naturally rise in value versus that of low-yielding countries.

The S&P/ASX 200 just closed at 3,955.30 points, up 1.56% yesterday. The price action has been consolidating its bullish move generated in early May. The last two weeks had been a non-directional market with up and down short-term moves, but it seems now that a new bullish trend is building up.

There was an immediate support level around 3,720 points which has been tested and validated several times this month. On the upside, the index seems to be capped around 3,950 points. This is the current level. The futures indicate that a positive session is possible today. A closing price above 4,000 points would be clearly a new strong signal that the bulls want to lead the index higher.

The indicators had shown that the momentum developed since March had weakened in May, and that the volatility was extremely low. That’s why the month of May was a consolidation period where investors made a pause after two months of rebound (March and April).

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Despite this rebound, the price action has not retraced yet (less than 25%) an important part of the decline that started in November 2007. There is potentially more to come and it would not mean that the long-term bearish trend is over. So how far can this rebound extend?

The indicators switched those past few days and turned back bullish. The MACD found some support on an ascending oblique line and has curved upward. It also crossed above its moving average 2 days ago, which conform that the momentum is strengthening. The Relative Strength Index (RSI) has spiked above the 50-value but does not show any overbought configuration.

If the price action confirms that a second wave of rebound is developing, the target of 4,200 points would probably be the immediate resistance. This level corresponds to the technical oblique line that comes from the historical high of November 2007 (point A) and that goes through lower highs (points B and C) of December 2007 and May 2008.

The FX market is quite choppy once again as risk appetite is coming back among investors. As a result, the US Dollar plunges against the major other currencies in the world, and the carry trade strategies re-appear to take advantage of the interest rate differentials between currencies.

The Greenback is currently on its lowest levels of the year: the EURUSD is trading around 1.4150, the AUDUSD around 0.81 and the GBPUSD around 1.64.

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The US Dollar index illustrates well this trend as the index lost 11.5% of its value since the high price posted in early March at 89.71 (point B on the chart). It is now trading around 79.43. One major technical crack occurred when the price action broke below its medium-term oblique support line (in green) in late April. Indeed, it was a clear signal that confirmed that the bullish trend which was in place since April 2008 (and more significantly since July 2008) had exhausted.

If we consider the whole upside move that occurred during almost one year, from April 2008 to March 2009 (between points A and B), the current correction has already retraced more than half of this upside move. A further correction to the 61.8% Fibonacci level is expected, but a technical rebound could immediately follow.

Indeed, the technical indicators area already very low. The MACD and the Momentum indicator have posted extreme weak values and may bottom soon. The RSI has just entered its oversold area.

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A move towards 78 is then possible in a first time. Then, both momentum indicators and oscillators would be clearly ready to bounce as it would become an opportunity to buy back the US Dollar for short-term countertrend.

The area between 77.5 and 78 could be a strong opportunity to fly back into the index as it is also a previous resistance that may become a new support (point C on the weekly chart).

The recent fall in the value of the Australian Dollar, while painful for Australians looking to travel overseas, has proven popular with many traders whose trading accounts are denominated in US Dollars.

From a traveller’s perspective, every cent that the Australian Dollar falls means less spending money in their pockets when they convert their Australian Dollars into US Dollars.

However, the sharp falls have eased the pain of those traders watching their US Dollar accounts erode in value with the strengthening Australian Dollar.

Imagine you were a trader who wanted to trade options on the US market. You open an account with a US Broker in 2002 and send over $A10,000 to fund your account. With an exchange rate of 0.5000, you now have $US5,000 in your account.

Now imagine you are a conservative trader and over those 6 years you managed to double your trading account. Your trading account is now $US10,000.

Now you decide to bring the money back to Australia. However, it’s 2008, and the exchange rate is now 0.9800 (98 cents). Suddenly, you need 98 US cents just to buy 1 Australian Dollar, whereas six years ago, you only needed 50 US cents.

Now your $US10,000 – which was double your initial investment - is only worth $A10,204. Nearly all of your gains have been wiped out by the exchange rate fluctuations. Can you see the importance of managing your currency risk?

Chart 1 below shows the weekly bar chart of the Australian Dollar (FXADUS in ProfitSource)

Chart 1

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As you can see, it is not just Currency Traders who are faced with the risks associated with changes in the exchange rate. Of course, had the trader waited until October to bring their US Dollars back to Australia, the exchange rate would have been much more favourable for them.

Anyone with any exposure to overseas currencies, whether through their trading, their travel plans, or business transactions needs to manage their currency risk.

So how can we go about it?

The simplest way to lock in the exchange rate today is to open an FX trading account. Let’s say we have some US Dollars sitting in a bank account in the United States.

If the Australian Dollar rises in value, the US Dollars will fall in value, meaning less Australian Dollars should we decide to bring the money to Australia. To lock in the current exchange rate, we can open an FX hedge by opening a currency position.

In any FX transaction, we are always buying one currency, and selling a second currency.

So in this case we would open a position that would buy Australian Dollars, and sell enough US Dollars to cover the money in our US bank account.

As long as there is enough money in your FX trading account to cover the margin on the trade, you will be able to leave this hedge open until you are ready to bring your US Dollars back to Australia. If Australian interest rates are higher than US interest rates, you can even be paid interest on your position, in what is called a “carry trade”.

If you have US Dollar exposure and you don’t check the exchange rates very often, it can be a good idea to hedge your position and lock in your exchange rate, to remove the possibilities of any nasty surprises.

There are other methods for locking in an exchange rate using Forward Exchange Contracts and options, however that is a subject for another article.