Since the end of the credit crunch of 2008 the best performing currency in the G-20 universe has been the Australian dollar. The unit nearly doubled from its panic low set in the aftermath of the Lehman bankruptcy rising from 62 cents to a dollar to a high of 1.10 as it became the preeminent risk trade in the currency market. However, now that the Aussie has come off its highs trading below parity to the greenback, investors are starting to wonder – is the party over for the commodity dollars of the Asia Pacific region?
All Yield to the Aussie
Aussieâ€™s multi-year strength as well as its near term weakness have all been driven by one single factor – interest rates. With interest rates in Europe, US and Japan trapped between 0 to 1% the hunt for yield has become an increasingly more difficult and desperate proposition for investors in the industrialized world. With G-3 central banks instituting long term Zero Interest Rate Policy to combat the deleveraging effects of the credit crunch Australia became the only AAA sovereign in the G-20 universe to offer investors any type of meaningful return.
China is Key
Boosted by insatiable commodity demand from China and other emerging growth economies of Asia, Australia saw only a very shallow recession in the post 2008 environment and was able to quickly return to solid growth in both GDP and employment by the start of 2009. In response to improving economic conditions, the RBA tightened interest rates to 4.75% by 2011 turning the Aussie into the preeminent carry trade against both the dollar and the yen.
However, that dynamic began to change abruptly at the end of last year as growth in China began to slow sending tremors through the mining dependent Australian economy. Employment growth which averaged more than 20K new jobs per month in 2010, slowed considerably in 2011 with the economy actually losing jobs in 5 out of 12 months in 2011. As a result, the RBA moved quickly to ease monetary policy dropping rates by 125 basis points in just 7 months taking the benchmark rate to 3.5%.
Ironically enough so far in 2012 Australian employment has been far more robust than market forecasts with the economy generating an average of 35K new jobs out of the past 4 of 5 months. To put that number in perspective, US with 15 times the population of Australia, has been able to muster only 100K jobs/month over the past three months. Therefore despite the clear slowdown in Chinese demand, Australia has been able to create more than 500K jobs/month on a population equivalent basis since the start of this year.
Nevertheless, policymakers and investors remain concerned. A bet on Australia is an implicit bet on global growth. Given the difficulties in the Eurozone, many market analysts remain bearish on the Aussie into the second half of the year. Europe accounts for 16.3% of China’s exports, 15.5% of India’s, and 9.3% of Malaysia’s. Asia’s slowdown is curbing demand for energy and commodities which produces a chain reaction: Weaker consumer demand in the West weakens manufacturing in Asia, which weakens natural-resource producers such as Australia.
This the reason why many Aussie bears believe that the RBA will continue to lower rates into the end of 2012 ultimately taking the benchmark to 3% as it further reduces Australiaâ€™s interest rate advantage versus the rest of the G-20. If Australian rates do fall to 3%, the unit likely to drift lower towards the .9000 level as 2012 comes to a close. There are however several offsetting factors that could reverse that dynamic. If the Fed implements QE3, the resulting boost to liquidity is likely to boost all risk assets including the Aussie, irrespective of global economic growth. Although the impact of QE has lessened with each iteration of the program, it nevertheless provides at least a temporary boost to financial assets. Secondly if growth in the US economy picks up in the second half of 2012 as result of lower oil prices, then it could serve as a locomotive for global demand in general, arresting any further decline in AUD/USD as growth in Asia stabilizes.
Finally the latest announcement by Bundesbank that it is considering adding the Australian dollar to its mix of currency reserves bodes well for long term prospects for the unit. Central banks like all investors try to maximize their rates of return. Given the fact that interest rates in G-3 are likely to remain 1% or below for at least several more years, Australia with its AAA sovereign ranking remains the only yield play around. Central banks are notoriously cautious investors and Bundesbankâ€™s announcement suggests that long term prospects for Aussie remain sound.
Unless the EZ dissolves this year creating world wide panic in financial markets, the Australian dollar may not see much further decline in it value as the year proceeds. After several years of unbridled appreciation the currency is likely to consolidate for the rest of 2012 trading in .9500 to 1.0500 range as global economy expands at a modest 1%-2% rate.