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June 29, 2011

Tide is Turning for the Aussie

Filed under: Australian Dollar — Tags: , , — admin @ 5:31 pm

“Australia is about to enter a boom that should last decades…The Australian dollar is unlikely to go back to where it was, and manufacturing will shrink in importance to the economy, perhaps even faster than it has been.” This, according to Martin Parkinson, Treasury Minister of Australia. While 30 years from now, Mr. Parkinson’s prognosis might probe to be accurate, I’m not so sure it applies to the period 3 months from now. Here’s why:

First of all, the putative economic boom that is taking place in Australia is being driven entirely by high commodity prices and surging production and exports. Since peaking at the end of April, commodity prices have fallen mightily. You can see from the chart above that there continues to exist a tight correlation between the AUD/USD and commodities prices. As commodities prices have fallen over the last two months, so has the Australian Dollar.


In addition, while demand will probably remain strong over the long-term, it may very well slacken over the short-term, due to declining economic growth across the industrialized world.  Consider also that Australia’s largest market for commodity exports – China – may have difficulty sustaining a GDP growth rate of 10%, and at the very least, new fixed-asset investment (which necessitates demand for raw materials) will temporarily peak in the immediate future.

Finally, the mining sector directly accounts for only 8% of Australia’s economy, which means that only to a limited extent to high commodities prices contribute to the bottom line of Australian GDP. This notion is reinforced by the 1.2% economic contraction in the second quarter – the biggest decline in 20 years – and the fact that GDP is basically flat over the last three quarters. Many non-mining economic indicators are sagging, and the number of corporate bankruptcies is 10% higher than in 2010. In the end, then, the ebb and flow of Australia’s fortune depends less on commodities, and more on other sectors.


Mr. Parkinson’s optimistic forecasts might also be undermined in the short-term by a looser-than-expected monetary policy. The Reserve Bank of Australia last hiked its benchmark interest rate in November 2010, and may not hike again for a few more months due to moderating economic growth and proportionally moderate inflation. Given that an attractive interest rate differential may be driving some of the speculative activity that has girded the Aussie’s rise, a decline in this differential could likewise propel it downward.

That’s because anecdotal reports suggest that the Australian Dollar remains a popular long currency for carry traders, funded by shorting the US Dollar, and to a lesser extent, Japanese Yen. Given that many of these carry trades are heavily leveraged, it wouldn’t take much to trigger a short squeeze and a rapid decline in the AUD/USD. For evidence of this phenomenon, one has to look no further back than May 2010, when the Aussie fell 10-15% in only three weeks.


Ultimately, as one commentator recently pointed out, the Aussie’s 70% rise since 2008 might better be seen as US Dollar weakness (which also catalyzed the rise in commodity prices). The apparent stabilizing of the dollar, then, might let some air out of the currency down under.

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May 31, 2011

Aussie is Breaking Away from Kiwi

Filed under: Australian Dollar — Tags: , , , , — admin @ 11:33 pm

The correlation between the Australian Dollar and New Zealand Dollar is among the strongest that exists between two currencies. Given their regional bond and similar dependence on commodities to drive economic growth, perhaps this is no wonder. Over the last year, however, the Aussie has slowly broken away from the Kiwi. While the correlation between the two remains strong, the emergence of distinct narratives has given rise to a clear chasm, which can be seen in the chart below. Given that the NZD is evidently among the most overvalued currencies in the world, does that mean the same can be said about the AUD?

Alas, geographic proximity aside, the two economies have very little in common. Australia is rich in coal, precious metals and other natural resources , while New Zealand produces and export primarily agricultural products. Granted, the prices for both types of commodities have exploded over the last decade (and especially the last year), but let’s be clear about the distinction. This has enabled both economies to achieve trade surpluses, but oddly current account deficits. Australia’s economy is projected to grow by more than 4% in 2011, compared to 2% in New Zealand. Australia’s benchmark interest rate is also higher, its capital markets are deeper, and the supply of its currency necessarily exceeds that of New Zealand.

Taken at face value, then, it would seem commonsensical that the Aussie should rise both against the Kiwi and the US Dollar. Indeed, it recently touched an all-time high against the latter, and is now firmly entrenched above parity. On a trade-weighted basis, it has been among the world’s best performers over the last two years.

In fact, some are wondering (myself included), whether the Australian Dollar might have risen too much for its own good. According to OECD valuations based on purchasing power parity (ppp), the Aussie is now 38% overvalued against the dollar, behind only the Swiss Franc and Norwegian Krone. In fact, exporters of non-commodity products (i.e. those whose customers are actually price-sensitive) have warned of mounting competitive pressures, declining sales, and inevitable price cuts. In other words, the portion of the Australian economy that doesn’t deal in commodities is actually in quite fragile shape. Given that China’s economy is projected to slow over the next two years and that booming investment in Australia’s mining sector should boost output, the commodity sector of the economy might soon face similar pressures.

For that reason, the Reserve Bank of Australia (RBA) has avoided raising its benchmark interest rate is fast as some analysts had expected, and inflation hawks had hoped. There is a chance for a 25 basis point hike as soon as June – bring the base rate to an even 5% – but the RBA’s own statements indicate that it probably won’t be until June and July. Regardless of when the RBA tightens, Australian interest rate differentials will remain strong for the foreseeable future, and likely continue to attract speculative inflows for as long as risk appetite remains strong.

So why does the Australian dollar continue to rise? It might have something to do with gold. As you can see from the chart above, the correlation between the Aussie and gold prices is almost just as strong as the relationship between the Aussie and the Kiwi. Given that Australia is the world’s second largest gold exporter, it is perhaps unsurprising that investors would see rising gold prices as a reason for buying the Australian dollar. However, it seems equally possible that demand for both is being driven by the pickup in risk appetite. While some gold buyers might counter that gold is best suited for those who are averse to risk (i.e. afraid that the financial system will collapse), the performance of gold over the last five years suggests that in fact the opposite is true. When risk appetite is high, speculators have bought gold and the Australian dollar (among other assets).

It’s unclear whether this will remain the case going forward. The Wall Street Journal recently reported that gold is increasing attracting risk-averse investment, as buyers fret about the eurozone sovereign debt crisis and other threats to the system. However, the same cannot be said about the Australian Dollar. For as long as risk is “on,” demand for the Aussie will remain intact. And if the Aussie Dollar Barometer survey – which found that “exporters expect the Australian dollar to reach a post-float record of $US1.16 by September and to remain above parity well into next year” – is any indication, risk appetite will indeed remain strong for the foreseeable future.

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April 2, 2011

Can the Australian Dollar Hold on to Record Gains?

Filed under: Australian Dollar — Tags: , , , , — admin @ 1:34 pm

The volatility of the last couple weeks has manifested itself in some unbelievable outcomes. In this post, I want to focus specifically on the Australian Dollar. When the Japanese disasters struck, the Aussie immediately tanked, as investors jettisoned risk and moved towards safe haven currencies. Only days later, it inexplicably rose 5%, en route to parity and a 28-year high against the US Dollar. The question is: will the Aussie hold on to these gains, or will it return to earth as soon as the markets come to terms with the misalignment with fundamentals?

The Australian Dollar remains buoyant largely because of interest rate differentials. Basically, Australia boasts the highest benchmark interest rates (4.75%) in the industrialized world, and investors are betting that it will rise further, perhaps to 5.5% by the end of 2011 and even higher in 2012. Given that the other G7 Central Banks probably won’t hike for a couple more quarters – and even then, rate hikes will be gradual and restrained – it’s only natural that yield seekers are flocking to the Aussie.

However, it seems possible that the markets have gotten ahead of themselves in presuming an airtight case for further rate hikes. While Australian inflation is somewhat high (2.7%), it has actually moderated slightly over the last six months. In addition, the rising Australian Dollar will help to mitigate inflation and hence make it less likely that the Reserve Bank of Australia (RBA) will hike rates. (How ironic that the markets’ bet on higher interest rates in Australia actually makes it less likely that those rate hikes will actually take place!).

Moreover, the domestic Australian economy isn’t performing as well as some people think. It is true that an investment boom in mining and a surge in commodities prices have provided an economic windfall. On the other hand, the strong Aussie has undermined strength in the manufacturing sector, the housing market is poised for correction, and the summer flooding will crimp at least .5% from 2011 GDP.

In fact, not only is it not guaranteed that the RBA will hike rates, but some analysts think it’s possible that the RBA will cut its benchmark cash rate before the end of the year. At the very least, analysts need to double check their assumptions and re-jigger their interest rates models.  Given that the Australian Dollar is primarily being supported by expectations for higher interest rates, that also means that investors to scale back their forecasts for the Australian Dollar.

Personally, I think that a bubble is beginning to form in currency markets, at least in certain corners of it. Due to commodity prices and relatively high interest rates, the Aussie is certainly one of the more attractive major currencies at the moment. At that same time, that it has risen so fast in the last few years – and especially in the last few weeks – strikes me as fundamentally illogical. At this point, its rise has become self-fulfilling; investors want it to rise, and so it does.

At this point, there are two possibilities. Either the markets will wait for fundamentals to catch up with the Aussie, and it will hover around parity or appreciate slightly, or investors will recognize that it has appreciated too much too fast, and its correction will become one of the major events in forex markets in 2011.

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January 21, 2011

Aussie May Have Peaked in 2010

Filed under: Australian Dollar — Tags: , , — admin @ 4:35 am

When offering forecasts for 2011, I feel like I can just take the stock phrase “______ is due for a correction” and apply it to one of any number of currencies. But let’s face it: 2009 – 2010 were banner years for commodity currencies and emerging market currencies, as investors shook off the credit crisis and piled back into risky assets. As a result, a widespread correction might be just what the doctor ordered, starting with the Australian Dollar.

By any measure, the Aussie was a standout in the forex markets in 2010. After getting off to a slow start, it rose a whopping 25% against the US Dollar, and breached parity (1:1) for the first time since it was launched in 1983. Just like with every currency, there is a narrative that can be used to explain the Aussie’s rise. High interest rates. Strong economic growth. In the end, though, it comes down to commodities.

If you chart the recent performance of the Australian Dollar, you will notice that it almost perfectly tracks the movement of commodities prices. (In fact, if not for the fact that commodities are more volatile than currencies, the two charts might line up perfectly!) By no coincidence, the structure of Australia’s economy is increasingly tilted towards the extraction, processing, and export of raw materials. As prices for these commodities have risen (tripling over the last decade), so, too, has demand for Australian currency.

To take this line of reasoning one step further, China represents the primary market for Australian commodities. “China, according to the Reserve Bank of Australia, accounts for around two-thirds of world iron ore demand, about one-third of aluminium ore demand and more than 45 per cent of global demand for coal.” In other words, saying that the Australian Dollar closely mirrors commodities prices is really an indirect way of saying that the Australian Dollar is simply a function of Chinese economic growth.

Going forward, there are many analysts who are trying to forecast the Aussie based on interest rates and risk appetite and the impact of this fall’s catastrophic floods. (For the record, the former will gradually rise from the current level of 4.75%, and the latter will shave .5% or so from Australian GDP, while it’s unclear to what extent the EU sovereign debt crisis will curtail risk appetite…but this is all beside the point.) What we should be focusing on is commodity prices, and more importantly, the Chinese economy.

Chinese GDP probably grew 10% in 2010, exceeding both economists’ forecasts and the goals of Chinese policymakers. The concern, however, is that the Chinese economic steamer is now powering forward at an uncontrollable speed, leaving asset bubbles and inflation in its wake. The People’s Bank of China has begun to cautiously lift interest rates, raise reserve ratios, and tighten the supply of credit. This should gradually trickle down in the form of price stability and more sustainable growth.

Some analysts don’t expect the Chinese economic juggernaut to slow down: “While there is always a chance of a slowdown in China, the authorities there have proved remarkably adept at getting that economy going again should it falter.” But remember- the issue is not whether its economy will suddenly falter, but whether those same “authorities” will deliberately engineer a slowdown, in order to prevent consumer prices and asset prices from rising inexorably.

The impact on the Aussie would be devastating. “A recent study by Fitch concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc.” [According to that same article, the number of hedge funds that is betting on a Chinese economic slowdown is increasing dramatically]. If the Aussie maintains its close correlation with commodity prices, then we can expect it to decline proportionately if/when China’s economy finally slows down.

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November 28, 2010

Australia Hikes Rates; How about the Carry Trade?

Filed under: Australian Dollar — Tags: , , , , , — admin @ 10:31 pm

Following up on my last post, I want to use this post to write about the long side of the carry trade- specifically the Australian Dollar. The Bank of International Settlements (BIS) observed in a recent report that, “The role of short-term interest rate differentials in both the deprecations and their reversal has grown over time.” When you consider that the benchmark interest rate in Australia is now 4% and that interest rates in every other industrialized country (including Japan) are close to 0%, it’s not hard to connect the dots.

Earlier this month, the Reserve Bank of Australia (RBA) raised the benchmark by .25% for the fourth time since it began tightening. In an accompanying press release, the RBA stated that “The board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process. It’s worth noting that the Australian Dollar barely budged, because investors had expected the move. The larger question was, and still is, the ultimate extent of RBA rate hikes and how soon it will get there.

Glen Stevens, Governor of the RBA, has himself indicated that ”rates are still 50 to 100 basis points, or hundredths of a percentage point, below normal.” If you do that math, that means that the RBA will hike rates to 4.5-5% before stopping. Other more bullish analysts think 5-6% is a more realistic expectation because it is closer to the long-term average of Australian rate hikes.

As to when the benchmark will reach that point, it’s anyone’s guess. Going forward, analysts have pegged the liklihood of an April rate hike at 40%. Said one analyst, “It’s now a line-ball call; indeed, if you put a gun to my head . . . I’d guess that the RBA is going to hike again by 25 basis points in April.” Still, most think that the RBA won’t hike again until May. Added another analyst, “They are not indicating any urgency. We think they will go again in a couple of months. It could be three months, it could be two, our formal view is two, that may depend on how the inflation numbers look.” It’s too early to project when the next next (after the next one) hike will take place, because it depends on the timing of the first one.

At this point, most Australian economic data is trending steadily in the right direction. “Australia’s economy is starting a new upswing…Unemployment fell to 5.3% in January, not far above levels considered full employment for the economy…A rebound in construction and an investment splurge in the mining sector are expected to restore growth in the economy back to historic averages by the end of 2010. The RBA has indicated it expects inflation to remain within its 2%-3% target band.” Without drilling too deeply into any of the other numbers, there’s very little reason to doubt that the Australian economic recovery is genuine, which reinforces the notion that it is only a question of when – not if – the RBA further hikes rates.

In fact, the picture surrounding the Australian Dollar is almost a mirror image of the Japanese Yen. While the Yen looks destined to fall irrespective of the carry trade, the Australian Dollar looks destined to fall. While further monetary easing in Japan will give the Yen a second life as a funding currency, higher rates in Australia will once again make it a popular long currency. In short, “With commodity prices likely to remain strong and the spread between Australian and US interest rates likely to widen further its only a matter of time before the Australian dollar breaches parity against the US dollar.”

In fact, the Australian Dollar just touched a 13-year high against the Euro – though that is as much due to the Greek debt crisis and Euro problems as it is with Aussie strength. Meanwhile, the Australian Dollar has zig-zagged against the US Dollar, and is now in a rising trend following a recovery in risk sentiment. Whether it sustains this momentum depends largely on whether the RBA hikes rates next month.

 

3m

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September 5, 2010

Australia Dollar Ebbs and Flows with Risk

Filed under: Australian Dollar — Tags: , , , , — admin @ 5:32 am

If you chart the course of the Australian Dollar over the last twelve months alongside the S&P 500, the overlap is jarring. You can see from the chart below that the two lines zig and zag in almost perfect unison. It would seem that there was a slight break in the second quarter of 2010, but even this is an illusion, since the Aussie and the S&P continued to rise and fall in the same patterns over that time period, differing only in degree of fluctuation.

Australian Dollar Versus S&P 500: 2009-2010
Since the S&P 500 is a pretty good proxy for risk it can be said that the Australian Dollar is a manifestation of investor risk appetite. When risk aversion was high, the S&P and the Aussie were low. When risk tolerance picked up, they rose. It’s funny how this came to be. It is probably best seen as a vestige from the credit crisis, whereby investors evenly divided assets into two classes: risky and safe. When you look at the performance of the Australian Dollar, it is pretty clear as to which side of the dividing line it was placed.

This is probably fair, since the Australian Dollar is a growth currency. According to the just-released Bank of International Settlements (BIS) Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, the Australian Dollar is now the world’s fifth most traded currency (behind only the G4: Dollar, Euro, Yen, & Pound), having usurped that position from the Swiss Franc. In 2010, it accounted for 7.6% (out of a total of 200%) of all trading volume, primarily as a result of trading in the USD/AUD currency pair, which was the fourth most popular in forex.

Investors have come to see the Australian Dollar in somewhat contradictory terms. It is both stable and liquid, but its economy is unpredictable and inflation is usually above average. The current economic situation was strong, with GDP growth projected to exceed 3% in 2010. Its benchmark interest rate (4.5%) is the highest in the industrialized world, and may touch 5% before the year is over. On the other hand, its political situation is currently uncertain, thanks to an election that produced a hung Parliament and the recent resignation of its Prime Minster. In addition, while its trade balance is currently in surplus, it fell in July thanks to decreased demand from China. Analysts wonder whether it isn’t entirely dependent on China (directly via exports and indirectly via high commodity prices) to generate positive GDP growth.

Australia Balance of Trade - 2009- July 2010
Ultimately, investors don’t care about any of this. They care only whether the global economy is stable and whether another financial/credit/economic crisis is likely to occur. Even though any such crisis will probably spare Australia, the Aussie is punished by even the whiff of crisis because Australia is perceived as being riskier to invest than the US, for example. “The Australian dollar is going to stay heavy. Markets don’t like uncertainty,” summarized JP Morgan.

Sadly, it’s currently not worth parsing the nuances of trade statistics and monetary policy, because it has no bearing on the Aussie, though at least this makes my job easier. For the time being, the Australian Dollar will tick up if it looks like the global economy (principally the US) will avoid a double-dip recession. Otherwise, it is in for the same rough stretch as the S&P.

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July 10, 2010

New Zealand Dollar Thriving in Obscurity

Filed under: Australian Dollar — Tags: , , , — admin @ 5:36 am

It’s understandable that forex investors basically ignore New Zealand. Its economy is around 10% the size of its neighbor Australia, its currency is less liquid, and spreads are higher. Given that its performance closely tracks the Australian Dollar, meanwhile, why pay it any attention?

NZD AUD 1 year

To be sure, the new currencies from Down Under trade in virtual lockstep, having strayed by only a few cents in either direction from their trading mean over the last year. Since the beginning of May, however, the Kiwi has staged an impressive rally, rising 8% against the Aussie in a matter of weeks. Perhaps, there is something worth analyzing after all!

According to most analysts, the sudden rise is largely a product of risk-appetite. Specifically, as the EU sovereign debt crisis stalls, investors are relaxing, and gradually moving capital back into growth currencies, like the New Zealand Dollar. In fact, the Kiwi recently rose to a one-month high on the same day that Spain successfully completed a bond auction.

For proof of this phenomenon, one need look no further than the close relationship between the NZD/USD rate and US stocks, as proxied by the S&P 500. You can see from the chart below that they have largely tracked each other over the last 12 months. This relationship seems to have intensified over the last few weeks, as the New Zealand Dollar sometimes takes its cues directly from releases of US economic data.

NZD USD 1 year

However, New Zealand economic fundamentals are also playing a role, perhaps even the dominant role. According to one analyst, “The NZ dollar had now recovered nearly all its losses of late May…Domestic fundamentals had contributed relatively more to the NZ dollar’s recent recovery than had the mild improvement in the global backdrop.” Unlike Australia, which has been racked by political disruptions and concerns over an economic slowdown by its largest trade partner (China), New Zealand continues to coast at a healthy pace.

Moody’s forecasts that New Zealand’s economy will expand by 2.4% in 2010, and “assuming a healthy global economy, New Zealand’s recovery should evolve into a self-sustaining expansion during 2011 and 2012.” This should set the stage for near-term rate hikes, beginning with an expected 25 basis point hike on July 29. Analysts project that the benchmark rate will reach 3.75% by the end of 2010, and 5% in 2011. Widening interest rate differentials, combined with the ongoing recovery in risk appetite, could turn the Kiwi into a popular carry trade currency.

Given that the Central Bank of Australia is also projected to further hike rates, it seems the Aussie will join the Kiwi in its upward march, and that the two currencies will continue to trade in lockstep. Options traders might try to construct a low volatility strategy, such as a short straddle or selling covered calls against the pair. For currency traders that prefer the Aussie, meanwhile, the New Zealand Dollar could serve as an attractive hedge.

Then again, it’s possible that both currencies could fade, especially if the EU debt crisis intensifies, and/or the global economic recovery stalls. In short, “The near-term outlook is…uncertain due to prevailing risk aversion that may weigh on the commodity currency universe.”

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June 13, 2010

Risk Aversion Hits Australian Dollar

Filed under: Australian Dollar — Tags: , , , , — admin @ 4:31 pm
These days, I feel like you could take that title and substitute pretty much any currency for the Australian Dollar. Let’s face it- the EU sovereign debt crisis has hit a number of currencies extremely hard, as investors have fled anything and everything risky, in favor of the US Dollar, Swiss Franc, Japanese Yen, and Gold.
 
Still, the Australian Dollar merits special attention, because in the forex markets, it has come to be a symbol of risk-taking. For veritable years, every credit expansion and economic boom has been accompanied by a surge in the value of the Aussie, and 2009 was no exception. As the global economy recovered and risk aversion ebbed, the Australian Dollar rose by more than 40% against the USD. It has been helped in its upward course by Chinese demand for its natural resources and strong interest rates, especially compared to the rest of the industrialized world.
AUD USD 2 Year Chart
 
That the Australian Dollar has already fallen 14% (from peak to trough) against the US Dollar over the last month is less due to economic and monetary factors, however, and more the result of an ebb in risk-taking. “The Australian dollar is considered a barometer of global risk appetite. Its fall reflects the quick change in mood, as Europe’s debt problems and China’s monetary tightening plans cloud expectations for the global economic growth,” summarized one analyst.
 
Specifically, investors are growing increasingly nervous about the viability of the carry trade, of which the Australian Dollar has been one of the primary beneficiaries. Uncertainty surrounding the fiscal problems of the Eurozone has catalyzed a spike in volatility, and investors have responded by rapidly unwinding their carry trade positions. Ironically, this caused a temporary upswing in the Euro, at the expense of the Aussie: ” ‘The euro rally isn’t that people like the euro. Investors have decided they want out of risk.’ The way to remove that risk from portfolios is to pay back the euro loans by selling the Australian dollar.”
 
From another standpoint, the yield advantage associated with holding Australian Dollars is no longer enough to compensate investors for the added risk. After adjusting for inflation, real interest rates in Australia are only about 2.5% (the nominal benchmark rate is 4.5%). This is still 2.5% higher than the benchmark US Federal Funds Rate, but not very attractive if you consider that the Australian Dollar has fallen by more than 2.5% against the US Dollar in several individual trading sessions in May. Moreover, the Reserve Bank of Australia (RBA) is signalling a pause in its rate hikes. If futures contracts are any indication, the Fed and the ECB will raise their respective interest rates before the RBA moves again.
 
Going forward, the consensus is that a sustainable level for the Australian Dollar based on current fundamentals is probably around .75 AUD/USD. However, the Aussie rallied 5% against the US Dollar last week, which suggests that investors still aren’t ready to give up completely: ” ‘The environment is not yet ripe to get truly bearish on the Australian dollar,’ said Commonwealth Bank Strategist Richard Grace. There are positives on the horizon, namely a better outlook for the U.S. and a calming of the Greek crisis, he said. He’s forecasting a return to $0.87.” Personally, I could see the Aussie going either way. Parity probably isn’t on the table anymore, but virtually everything else still is.

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March 27, 2010

Australian Dollar Rises Despite Unwinding of Carry Trade

Filed under: Australian Dollar — Tags: , , , , , , — admin @ 11:08 am

When two weeks ago the Royal Bank of Australia (RBA) cut interest rates, one would have expected the Australian Dollar to suffer proportionately. Instead, the currency continued its steady upward rise, and touched a six-month high, before falling back slightly. One surprised analyst lamented, “These types of inconsistencies can make trading forex difficult or down right frustrating at times.”

The interest rate cut marked the sixth since September, since which point the RBA has trimmed its benchmark lending rate by 425 basis points, leaving it at 3%. [See chart below courtesy of “The Fundamental Analyst.”] Traders have reacted to the successive declines in yield and simultaneous pickup in risk aversion by unwinding carry trades, many of which had been long the Australian Dollar. The massive sell-off that ensued left the Aussie a long way below the level of parity with the USD, which only last year many analysts had viewed as inevitable.

rba-cash-rate-apr09

The most recent rate cut, in contrast, was greeted positively by traders, perhaps because they were expecting a larger (50 basis point) rate cut, but more likely because their priorities had changed. A pickup in risk aversion in recent weeks has definitely reinvigorated interest in comparatively risky currencies such as the Australian Dollar. Overall, the markets remain risk-averse, and investors are increasingly making bets in accordance with economic fundamentals, rather than yield levels. ” ‘The focus will remain on the global backdrop…Risk appetite is still fragile and the market is increasingly realizing that the recent recovery was excessive.’ ”

In the case of the Australian Dollar, traders were heartened by the RBA’s decision to lower interest rates to a 49-year low since it reflected the Bank’s commitment to dealing with the economic crisis. But at this point, the Australian economy is still in poor shape. “Prime Minister Kevin Rudd said yesterday for the first time that a recession in Australia is inevitable amid a slump in global growth that is eroding demand for natural resources from the world’s biggest shipper of coal and iron ore.”

Meanwhile, “The global economic downturn has pushed Australia’s economy into its first recession since 1991, Reserve Bank of Australia Governor Glen Stevens said.” According to the minutes from the RBA’s last meeting, “Conditions in the labor market continued to soften” and “Further falls in employment and rises in unemployment were expected.” These observations should be viewed in the context of a 5.7% unemployment rate.

The near-term prognosis for the Australian economy remains quite poor, regardless of whether a recovery materializes in 2010, as forecast by economists. Accordingly, analysts expect the RBA to lower its benchmark interest rate further, probably to 2.25% or 2.5%; there is a “bias toward further modest rate cuts, although we continue to think that the RBA may well pause for a few months to assess the impact of the current round of fiscal stimulus,” offered one forecaster.

Given the lull in market activity, some commentators have turned to technical analysis. “Westpac Currency strategist Robert Rennie said their own risk measurement models are clearly flagging a bumpy period ahead for high yielding currencies. ‘Our proprietary models are…clearly telling us to watch risk sentiment and data much more closely than we have over the past six weeks.’ ” In short, traders should not become complacent as result of the Aussie’s recent rally, and should continue to monitor economic data for signs of progress and/or hiccups on the road to recovery.

australian-dollar-rises

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Australian, New Zealand Currencies Benefit from Risk Aversion

Filed under: Australian Dollar — Tags: , , , , , , — admin @ 10:28 am

Against each other, the New Zealand Kiwi and Australian Dollar have traded in a pretty tight range for the last year (except for a “blip” in the fall of 2008). This makes sense, as both currencies rise and fall in accordance with exports and interest rates.
nzd-and-aud-trade-in-tight-range
Against other currencies, meanwhile, both have torn upwards in the last couple months. Despite steep interest rate cuts, both currencies have maintained their interest rate advantages against other industrialized currencies. This has not gone unnoticed, and the return of the carry trade has been kind. “The current improvement in sentiment is providing an underpinning of support and while that remains the case – and that may be until midyear – the New Zealand dollar is going to remain well-supported,” said one economist.

The correlation between the New Zealand Kiwi, specifically, with the US stock market has become remarkably cut-and-dried of late, which you can see from the chart below. For carry traders, therefore, it probably makes more sense to follow stock market commentary than to track New Zealand economic data. The same economist, for example, warned “that the equities rally, which has seen the broad U.S. Standard & Poor’s 500 index climb 36% from its March low after rising another 3.4% Monday to its highest since Jan. 8, may be dissipating.”
us-equities-and-nzd-usd
Besides, given the deteriorating economics in both countries, lower interest rates are probably inevitable: “We think this case for further cuts will be made in the second half of this year…we think it will be very difficult, no matter what the global economy is doing, for the RBA to ignore rapidly rising unemployment,” offered one analyst who predicted that rates would be cut to a “trough of 2%.” In such a scenario, the interest rate spread would still remain healthy, but perhaps not enough to offset the additional risk.

Australian home prices are falling at a rapid clip, the labor market is sagging. In New Zealand, meanwhile, a decline in sentiment and consumer spending has corresponded with a 1% contraction in GDP in the quarter ended March 31. Tourism is down, although net exports are increasing. The current account deficit continues to expand, but this is mostly a product of an investment balance – perhaps related to the carry trade.

new-zealand-2009-current-account-balance

For now, forex traders remain optimistic, albeit slightly less so than before: “The difference in the number of wagers by hedge funds and other large speculators on an advance in the Australian dollar compared with those on a drop — so-called net longs — was 16,692 on April 28, compared with net longs of 17,250 a week earlier.”

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