How to (Carefully) Play the Aussie Dollar Short Trade—Searching for Alpha for December 2013

Referring to the Australian dollar short trade in a recent article, Forbes magazine called it the next “Big Short,” in deference to the Michael Lewis book about the 2008 mortgage crisis. But I wouldn’t be quick to bet on the downtrend in the Aussie dollar just yet. 

There are lots of fundamental reasons why the Aussie dollar has been in a freefall for most of the year. The mining boom has slumped, leaving the commodity-dependent Australian economy in a bind. The Chinese economy, which typically imports vast amounts of Aussie raw materials, has slowed. Growing budget deficits and political instability has also clouded the outlook for the country. Word that George Soros started shorting the Aussie currency in late Spring added to the already bearish tone of the market. 

The weakness in the Aussie dollar was further highlighted in a recent Goldman Sachs report.  As one of their top trading ideas of 2014, the bank recommended last week that investors buy the S&P 500 index while shorting the Australian currency. 

The foundation for this idea is Goldman’s belief in the acceleration of U.S. economic growth. The short Aussie position is meant to hedge the trade against rising U.S. interest rates.