Australian dollar bulls and bears

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Macro Afternoon

A couple of competing stories in the press this morning highlight one of the reasons that the AUD/USD rate has been stuck in a range for some time now.

In The Australian this morning we have the headline “China risk jangles nerves on high dollar” while over at the SMH we have “As might dragon roars so will Aussie”.

We have a market!

The reality is, however, that neither of these articles are inconsistent with each other. As I wrote yesterday, it is a question of time frames. Because, what we essentially have in these articles is China bulls and China bears but while the bears are worried about the here and now the bulls are focussed on the longer term.

Neither is inconsistent nor off the mark.

Take for example the bullish SMH Aussie article that quotes an old colleague of mine, Richard Franulovich, who is based at Westpac in New York,

“The real question is whether the rise of China is a bubble, because if its spectacular rise of the last decade is running out of legs then the Aussie dollar’s ascendancy is also on borrowed time,” he said. “We, for what it is worth, think that China’s rise has many years, if not decades, to play out.”

Dead right on both counts. If China goes pop so does sentiment toward the Aussie but if you think that China is a long term growth trajectory, as I do, then the Aussie can remain strong insofar as it won’t fall as far as it used to. There is nothing wrong with this logic it is entirely appropriate but it means you have to be vigilant in watching the China situation for early warning signs of trouble so you can exit your trade.
And so it is that the bearish Aussie article in The Australian is negative because it is full of China bears,
Some big investors are starting to worry about the Australian dollar, which has soared 75 per cent against its US peer since the depths of the financial crisis. These sceptics expect the currency, which recently hit its highest level against the greenback since being freely floated in 1983, to run out of fuel — or worse, to collapse.

Their concern is that China, Australia’s biggest trading partner, could hit a major economic slowdown, cooling its enormous demand for prized exports such as iron ore, coal, and gas.

The Australian dollar “has gotten ahead of itself”, says Dori Levanoni, partner at First Quadrant, a Californian investment fund that manages some $US18 billion ($16.7bn) and has made bets against the Australian dollar in recent months.

Edinburgh-based Standard Life Investments, which manages $US250bn in assets, is scaling back its bets on Australian government bonds after buying aggressively early this year.

“Gotten ahead of itself” isn’t the best analysis I’ve ever heard but I get what he means. If you see all these risks in global markets and the economy and you couple this with fears about China then, as has always been the case, the Aussie should be under pressure. It’s as simple and easy as that.
Although it’s not is it?
The Aussie pulled back from 1.10 but then has steadfastly held above the 1.02/1.0350 in the face of all of the recent market turmoil. Franulovich of Westpac makes this point when he says,

“The current global economic environment would have been fertile ground for a big pull-back in the Aussie dollar,” Franulovich said.

“People are concerned about China slowing, there are stresses in Greece, now Italy on the sovereign front, the US economy is looking soggy. A year or two or three ago the Aussie dollar would have collapsed quite sharply in this environment.

“In fact, in the past two to three months it has been tracking at $US1.06 to $US1.08 range, which is a real-life test of the Aussie dollar’s new safe-haven status.”

And it’s true that the Aussie has been holding in really well and the excuses were there for the sellers to take the ascendancy but I think it’s too early to declare the Aussie the south pacific gold standard. Just think about where the low points have been over the past couple of months. They have been synchronous with markets going to the brink. The Aussie has only come back because markets have come back, the Dow and S&P hold important trendline support, a politician somewhere makes soothing noises and the market steps back from the precipice and so on.

So I’m not convinced yet that even though I think the Aussie has been rerated by the market that it won’t, when or if markets do have a serious risk off event, resume normal production and fall precipitously.

The difference now is that I think there are enough long term China and India bulls that it won’t need to fall to 60 or 70 to find support it will probably be somewhat higher. Obviously it depends on the catalyst but while some may think the Aussie has “gotten ahead of itself” those same bods will also being buying again when it falls. The long term, commodity lead positives for the Aussie are just too compelling.

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  1. Its all about terms of trade. That falls the AUD falls significantly.

    In the end, the next 7-8 years will be a commodity driven, so long term support is definitely there.

      • …well, if we do have big housing bubble, wouldn’t it be fair to argue that such a low IR is, indeed, possible?

        Hence, wouldn’t an AUD/USD (all being the same for the USD, which probably won’t…!) much lower than current be possible?

        Interesting, indeed…

  2. What effect will a contracting housing market have on the dollar? Is international investment in housing development significant enough (relative to mining investment) to have an effect?

  3. My 2c.

    AUD is carry trade fantasy.

    In 2007 China was buying our minerals and the dollar nudged 0.90. In 2008 it established above 0.90. Then interbank lending rates spike with a (Lehmann)credit crunch.

    She plummets 40% as the carry unwinds and USD and YEN are repatriated.

    Meanwhile China still bought the minerals. The slight decrease in exports to China was in Nov 08 A MONTH AFTER the AUD fall.

    In March 09 exports were 40% up on their pre Lehmann levels tet the AUD was still wobbling under 0.70.

    Its a risk currency that does fine when credit flows and the world is swamped with cash.

    Ponzi Peso?

    • Deus Forex Machina

      Rota…the history of the Aussies free float tells us that you are morwe likely to be right than not…you know what i think of those terrible words “this time its different” so i won’t be saying them

      I guess the hypothesis to be tested is whether the notion of rerating is real or just a fabrication of current settings in global markets as you allude to

      i reckon the truth is somewhere in between so if we get a real market dislocation not these pseudo moves we’ve seen recently the Aussie will likely get hit…the question is how far and on that the where and the why for the dislocation become important…

      i will not be trying to catch the falling knife when or if a big fall occurs…but i will no doubt try and call the bottom when i think I see it

      • DFM, though i consider myself an AUD bear for what i consider to be very good reasons (of course!!), i better and better appreciate what you are saying about rerating.

        I must confess that for sometime i haven’t expected the USD to be quite so, well, crap…and that is the other side of the AUD/USD equation, naturally.

        Hence, maybe a “crash” with a re-rated AUD will mean a “crash” to 60-80, rather than a “crash” to 30-50?


        i do value your thoughts, though, thanks.


        • Deus Forex Machina

          Hi Stew…please see my reply to El Zorro below…

          Aussie is off a cent thanks to billy boy evans new call on rate cuts and is likely going lower

          i want to see 80 becaus ei think its better for our economy and we’ll just have to see where the new top and tail of the cycles are from now on

          i dont want to see it at 60 though because that would imply an australian economic debacle on top of a global catastrophe – which no one really wants

  4. El Zorro Dorado

    The Aussie $ is an accident waiting to happen…the empress of an emperor with few clothes. It wil be hit ( like other high yield currencies) when the US market next reflects an honest appraisal of US short term recovery prospects, and when the EZ recognizes its fundamental flaws really are too big to paper over or kick down the road. Woe betide the dollar though if such coincides with a true accounting of the China bubble. While China seems a good long term positive bet, its inherent road-bumps –credit bubbles, politics, demography, two-speed modernisation, corruption, and of course, its history ( to name a few) –augur for substanial hiccups for all those hanging on its dress. On the other hand, the US’s prospects are none too rosy either, especially if Bernankes Bistro is opening late to serve out Queeassy pints. But they may be better than most of the ROW, and the US $ may –despite its many failings — get to wear the yellow jersey again.If only for a short time. The point is that the short term risks from all angles are so great and conflicting that any time horizon more than a few days seems exceptionally brave. Having said that –and in keeping with the new era’s version of guilt, shame, and responsibility– I put the Aussie at 82/84 before years end.

    • Deus Forex Machina

      hey ezd…if aussie is crap, euro is crap and usd is crappola as well then which one actually falls?? these things are bilateral so they really are ugly sister contests…

      I don’t disagree that aud is going to trade lower at some point but a bounce of 82 would actually make the point about rerating – it went to 59 in the first wave of this crisis and .4775 in 2001

      starting points are important and a drop into the 80’s is a big one but a low in the low 80’s in the grand scheme of things over the post 71 era would actually be a really strong performance

      i’m trying to simply reflect a really long term horizon here not a trading view if you know what i mean so i’m not disagreeing with you its just i’m looking through a slightly different lens

  5. The AUD has gone through a structural realignment with currencies. Falling back to the 50’s, 60’s, 70’s or even 80’s is going to take a significant falls in the prices of the basket of commodities globally.

    Gold – No chance
    Silver – MUnlikey, but maybe down its 200day ma.
    Bulk Commodities – Still huge demand for coal and iron ore.

    Inflation is THE ONLY WAY to rid the world of all this debt. There will be QE3,QE4, QE5 until all the debt is inflated away.

    The AUD will likely hit new highs by the end of the year.

  6. The AUD has been very resistant to downside pressure, but mostly I think this reflects its place in global portfolios, which allocate a few points to riskier currencies/assets. The thing is, if you are a NY or London fund manager and plan to keep, say, 10% of your funds in “risk” assets, and you decide to sell AUD, what do you buy instead? CAD? NZD? SGD? Copper futures? Wool futures? Gold? There are not many choices, so the AUD is benefiting from the absence of competitors.

    As long as investors are willing to put some cash into better-yielding-but-less-liquid markets, the AUD is safe enough on the downside.

    I reckon that if things settle down in Europe and the US sort out their fiscal/debt/political brawl, then the risk is on the upside for the AUD. The low side is giving off a good bounce.

    • I think you seriously need to research carry trading. Its borrow at low percent (most of the western world and Japan) and invest in higher yielding assets. If Australia was at 1% OCR the Aussie would dream od 0.40

      • Deus Forex Machina

        hey rota…aussie has always been a carry trade

        my aud model i built more than 10 years ago was essentially (crudely),

        aud = comms + IR Diffs + risk index + usd

        when we look at the explanatory variables IR Diffs were important but not the most important…its the same now

        however you are right that if the RBA Cash rate was 1% AUD would be lower but the settings in the domestic and global economy and china that would be required to get the rate to 1% would be the overriding reason the aussie got smashed not just the “carry” element.


  7. MontagueCapulet

    I think the long-term China story needs to be questioned as well. There’s too much willingness to believe China will surpass the USA. People used to say that about Japan – how did that work out?

    If you look at the long-term demographics, China has a terrible age stucture post 2030 – similar to what Japan has experienced since 1990, with a declining and aging population and fertility below replacement rates. The USA does not have this issue.

    Based on demographics, we could expect China to keep growing until 2030 and then decline. However, the scale of their overbuilding is such that they will have built all the infrastructure and housing they need in 2030 by 2014. In other words, they will have brought forward all the demand through to 2030 within a few years.
    They may thus manage to create such a huge Japanese-style boom and bust that when the bubble pops they stagnate all the way through to their demographic peak in 2030, and then keep stagnating for demographic reasons.

    • By 2014, not quite. But I generally think it wise to bear in mind what you say. I am somteimes here as China Fanboy, in fact I’m China realist – as in, it’s not over until it’s over. I do think the China story may surprise us all and in ways we may not necessarily expect.

      But we are connected at the hip, and we must hope for a soft landing.

      I’ll go for optimism, pessimism is so dispiriting.


  8. “We, for what it is worth, think that China’s rise has many years, if not decades, to play out.”

    They said that about Dubia and Japan their govt had tons of money in the coffers too.

    It aint going to boom for decades. Show me an economy that did this. Never has this happened and China wont be any different

  9. “People are concerned about China slowing, there are stresses in Greece, now Italy on the sovereign front, the US economy is looking soggy. A year or two or three ago the Aussie dollar would have collapsed quite sharply in this environment.”

    The only reason the Aussie has held up is because it has one of the highest interest rates in the world. With all the debt consumers are holding now it is starting to bring major cracks in the Aussie economy. The RBA could be on the verge of lowering interest rates because of this. When that happens the AUD will go down. The AUD is only high because of the interest rates not because Australia has a sound economy. Hedge Fund Managers and investors are seeig this and starting to short Australia banks. The question will be with all the consumer debt transfer over to the govt with its guarantees coming to light in Oct. Things are looking good in the land down under and the world investors are starting to see this.

    • Things are not looking in the land down under and the world investors are starting to see this.