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    As AUD/USD retests 0.74, has the Australian dollar bottomed out?

    The Australian dollar has been depreciating since the spring of 2013 as global commodity prices have tumbled on softening demand, particularly from China. The Australian economy came out of the world financial crisis relatively unscathed as strong demand in China for commodities such as iron ore – Australia’s main export – drove economic growth.

    But a slowing economy in China, combined with the rout in oil prices and a strong US dollar, has pushed commodity prices to multi-year lows, hitting Australian exports. GDP growth fell to 0.2% in the second quarter of the year, the slowest in two years. While unemployment has increased from around 5% in 2012 to over 6% in 2015.

    With inflation dropping sharply from 3% in 2014 to around 1.5% this year, the Reserve Bank of Australia (RBA) has cut interest rates twice since February by 0.25% each to help rebalance the economy away from commodity exports. The RBA has signalled that further easing may be necessary but changed its tone at its August meeting by no longer calling for the further depreciation of the Australian dollar.  This provided some support to the aussie but growing concerns over the health of the Chinese economy pushed the AUD/USD pair to a new 6½-year low of 0.6907 on September 4.

    The outlook for the currency has since tilted to the upside as commodity prices have rallied somewhat following the US Federal Reserve’s decision not to raise interest rates at its September meeting. Markets now expect the Fed to delay a rate hike until the beginning of 2016. This has helped lift sentiment in financial markets after the high volatility seen in August. Meanwhile, recent economic data has shown business and consumer confidence holding up while unemployment appears to have peaked and was steady at 6.2% in September.

    The large trade deficit perhaps poses the biggest risk to the Australian economy and may push the aussie lower if commodity prices do not substantially recover from current levels. The timing of the Fed’s rate rise and the developments with China’s economic slowdown are also likely to greatly influence the aussie’s path in the near term.

    The aussie has posted an impressive rally since late September, climbing from 0.6981 to a high of 0.7381 on October 12 against the US dollar. It has since eased slightly and was last trading at 0.7337 by mid-European session on Thursday. Whether the aussie can sustain its recent gains will depend on how the various downside risks play out in the coming months.

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