I normally stay out of politics. It is something I learned working in funds management and for the major banks for much of the last quarter century. Commenting on politics is not something that is looked highly upon. That is not to say that back in 2000 and 2001 when I was saying that the Aussie dollar was going under 50 cents that it didn’t stop some related to government to try to gag my calls. But that is the way of politics in this country – it only seems to run one way.
Barracking for one side of politics is not my style as I recognise that either government in power can only deal with the economy that faces it and that a large part of what they can achieve is related to what the independent central bank does and does not do.
But today I am going to comment on the Gillard government and its failure of vision about the impact of what they do and say in public regarding the Australian dollar.
Yesterday the Government admitted that there is a $12 billion hole in revenues. For a number of years MB has been warning about the state of the Australian economy, its imbalances and its underlying structural problems due to the reliance on, to coin a phrase, House and Holes. We have argued that the unmitigated high Aussie dollar is a boon to consumers but not to the fabric of the Australian economy in the long run.
But the Australian Government has been more interested in playing the political game and has consistently said that everything is rosy, has consistently forecast surplus after surplus, has forecast huge mining revenues, big company receipts and a strong economy. Yet for more than a couple of years now they keep undershooting their targets on almost everything.
The impact of this is that the Australian dollar has been bid up by central banks and others around the world excited by the safe harbour that Australia has offered them in a world of economic turmoil.
It is not difficult to fathom how much semi-hot money is sitting in Aussie dollars taking shelter from the global storm and how much of that money might flow out once the thought hits them that the Australian Government’s Panglossian outlook for the economy and for interest rates might be a mirage. The picture above tells the story – foreigners held $32.6 billion in June 2007 when the GFC started and they held $213.4 as at the end of 2012. Then we have the billions of bank debt and sitting on Australian bank balance sheets to contend with.
It would be hysterical at this point to suggest that all of these bonds are going to hit the market and drive the Aussie dollar to 60 cents but it is worth thinking about what drove the Aussie higher and then think about what might drive it lower again.
The key drivers of the Aussie can be distilled into 5 core themes which are:
- global and Australian growth outlook
- interest rate differentials
- investor sentiment
- the USD
Over the past few years, since 2009 when the Australian economy didn’t implode and the housing market didn’t crash the way many foreigners thought it might, the miracle Down Under has supported the Aussie dollar in a significant manner.
Investors have consistently told us that they like the Aussie because:
- Australia remains a strong economy compared to the rest of the world
- we are close to China and have a mining boom
- it has a big positive carry (interest rate pick up) relative to other developed markets
- rates look likely to stay put for a while
- the sovereign has a strong balance sheet with low debt and a healthy budget
- the US dollar has been largely under pressure
- the Aussie was in an up trend
- Australia has a free float with not much chance in intervention from the RBA
All of which combine to give us positive sentiment toward Australia and the Aussie dollar and all of which have been reinforced by the free money culture of the Fed and other central banks.
But with the Government now signalling that the economy is weaker than forecast, that revenues are under pressure, and that it is going to continue to spend on the big ticket items it has on its agenda, then it is going to have to cut back somewhere and thus even with a deficit risk a fiscal contraction at the household level at a time when Australian households continue to labour under too much debt even as the mining boom and mining investment boom is unwinding.
So the outlook for Australian growth and thus Australian interest rates is to the downside while the outlook for the Australian balance sheet is for a serious deterioration. Australia is likely to have to borrow more from the market and is likely to be in structural deficit for some time.
Keynes might be pleased by the Government’s plans but there is a growing chance that international investors thinking that Australia was different from the rest of the world recognise that perhaps we are just going to be impacted later than the rest of the world rather than not impacted.
Which means that a flight could be around the corner from the Australian dollar and it might be sooner than many think if this weekly chart is any guide.
We have a lifestyle short on the AUDUSD at the moment. I think that taking some cover is worthy of thought for traders and corporations alike.