The United States Peso

MELBOURNE AUSTRALIA, 1 December 2006 – We are unsure what to call it.  The United States Peso seems too obvious.  Perhaps the American Lira would work.  Or any combination of United, States, America, Peso, Lira or Shekel, should work.  Today, Reuters tells us, the “Australian Dollar rose to a new 20-month high against the US dollar” ably assisted by the stronger than expected retail sales figures.

As we write, the Aussie is sitting just under USD$0.79.  It has been there a couple of times before during the last three years and each time its ability to burst through the 80 cent level has proved fruitless.  Could it be different this time?

Robert Rennie, chief currency strategist at Westpac Bank said “If we continue to get strong data and if we continue to get weakness in the US dollar, it’s certainly not out of the realms of possibility that we see the Aussie going further.  It feels as if the carry trade is still very much alive and that is one factor that means the Aussie and other high-yield currencies are still at risk of making fresh highs.”

For those unfamiliar with the ‘carry trade’ it effectively mean as borrowing in a low yielding currency, the most obvious being the Japanese Yen, and then buying assets in a higher yielding currency, such as for instance the Australian dollar.

And with retail spending still apparently unabated despite the rising interest rates, and with fuel costs around 30% lower than the peak, the threat of a further interest rate rise and therefore a higher Aussie dollar cannot be discounted.  As Michael Thomas, chief economist at ICAP confirmed, “At the moment the RBA is still close to putting rates up again.”

Stephen Koukoulas  at TD Securities told Reuters that “The economy is still doing well, sufficiently well to keep inflation a little higher and it does nothing to dissuade the RBA from having a strong tightening bias.”  Our memory tells us that in a recent survey by Bloomberg News, Koukoulas was one of those anticipating a further 50 basis point rise in rates by the middle of next year.

It isn’t just the Aussie that’s knocking the US Lira for six.  The British pound sterling is also having a crack at pushing it over the precipice.  Custom House Global Foreign Exchange tells us that “Not since 1992 has the GBP been at these levels, when in September of that year it hit USD$2.00 as Britain crashed out of the European Exchange Rate Mechanism [ERM].”

During those tumultuous times the GBP was under severe pressure from the strength of the Deutschemark.  The ERM was designed to keep all European currencies – when they existed – within a band in order to stabilize exchange rates prior to the gradual introduction of full currency union.

The idea was that the separate central banks would buy and sell each others currency in order to maintain the exchange rates within those target bands.  However, the Bundesbank wasn’t keen to help out the Bank of England believing that the GBP should instead be devalued to a revised target band.

Eventually, as Custom House explain, the “Bank of England raised interest rates to 15% in trying to defend the pound against a soaring German mark.”  As we know, it ended in tears and big George Soros made his billions and international fame.

So far there haven’t been too many visible tears, but things can only go on for so long before it does all go pear shaped.  This is worth keeping a very close eye on.

Kris Sayce

Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005.
He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.

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