The stock market continues to creep in its petty pace, from day to day (channelling Macbeth). The Aussie is up 6% against the USD in the last two months. Meanwhile, base metals prices are down 6%.
Something does not compute. That’s pretty much what the Reserve Bank of Australia (RBA) said yesterday. The RBA elected to leave the cash rate unchanged. But it pointed out that the Aussie dollar has remained high despite, ‘the observed decline in the terms of trade and the weaker global outlook.’
In other words, as a growth currency, the Aussie shouldn’t be strong. Global growth is off the boil. Key commodities like iron ore and coal are coming off all-time highs. Australia’s export income may stay high in nominal terms, but it will do so because of increased export volumes on lower prices. The days of fat margins on double digit price gains are probably over.
If the commodity boom isn’t driving the currency, then it must be the yield right? Well it could be the yield. But at 3.5%, even AAA rated government debt is somewhat less attractive than corporate debt. What is left to explain the influx of capital into the Aussie dollar?
Our conclusion? Any port in a storm! The best thing the Aussie has going for it is that it’s not the US dollar and it’s not the euro. It’s true that public debt as a percentage of GDP is much lower here than in the US and Europe. But it’s also true that five years ago the government had a $40 billion surplus. Now it has over $200 billion in debt and counting. The fiscal picture is better than Europe and America, but only relatively.
Still, if you were a multinational company masquerading as a neo-feudal city-state, you might well choose to warehouse some of your cash booty on these fair shores with golden soil and wealth for toil! It’s all about currency diversification in the age of monetary disintegration.
For example, today’s Australian Financial Review reports that tech companies like Google, Microsoft, and Apple have, ‘stored some of their cash reserves in Australian government bonds,’ adding to demand for the Aussie dollar. This follows Russia’s central bank, Germany’s Bundesbank, and the Banque de France all increasing their holdings of the Australian dollar as a reserve currency.
A few years ago, you probably would have described these moves as speculation on China, growth, and higher commodity prices. Today, we’d describe these moves as a frantic attempt to avoid the wealth destruction of a European currency break up. In fact, if you look at the Aussie dollar versus the euro over the last six years, you’ll see exactly what we’re referring to.
The initial shock of the Lehman Brother’s collapse sent the Aussie down against the euro in late 2009. But since then, even though the Aussie is commonly thought of as a risk/China/growth play, the currency has belted the euro, rising by 88%. It’s not at parity yet. But that’s not unthinkable, given how intractable Europe’s political problems are.
It may take a much lower euro for the political factions in Europe to agree on mutualising their debt markets. A eurobond — where Spain, Italy and Greece can borrow on Germany’s good credit — would probably be just the structural reform to trigger a big rally in the euro and a mean reversion in the Aussie.
It wouldn’t surprise us to see a 20-30% fall in the Aussie, in fact. But maybe not right away. Things have to get stronger before they get weaker. The chart below shows the US dollar index and its 10- and 35-day moving averages (MAs). Murray (currently on the job in New York as part of his world tour) uses these MAs to estimate short-term price trends. Take a look below.
The chart shows that the 10-day MA is on the verge of crossing the 35-day MA in the dollar index. If it does, you should expect to see the Aussie go back to an all-time high against the USD. You might even see the US dollar price of gold rally, although the rally in the Aussie will negate this for local investors.
Why bother with all this technical analysis of currency movements? We’re looking for price signals. The stock indices are no longer communicating any useful information about the real state of the economy or corporate profits. The Fed has effectively monetised everything and destroyed price discovery in the stock market.
But the currency market is still flashing some useful signs. And signs tell us that the petty pace of the North American summer, in which nothing dramatic happens in the share market, may soon become a bit more manic. Shake off your lethargy and get ready.
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From the Archives…
As Draghi Drags the European Crisis On
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China’s Economy – How the Devil is in the Detail
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The Greatest Interest Rate Fix featuring… Mario Draghi and Friends
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What the Credit Boom Left Behind
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The Australian Economy: A Case Study in Weirdness
30-07-2012 – Greg Canavan