Beautiful one day, hideous the next
The Aussie dollar has been the darling of the currency landscape for the past two years and its rise has rewarded well those who have ploughed their money into it.
And as other risk markets swoon, just like a teenager after his first kiss, the love affair of forex traders, global portfolio managers and central bankers diversifying their sovereign assets has been intensifying at a scary rate.
Yet continuing the analogy, at its basest level, forex markets are just plain old beauty contests. Unlike the stock markets where you can by BHP Billiton or Woolworths and not be too concerned about where the others go, in foreign exchange when you buy one currency you are always selling another.
In currencies it’s not about finding someone to love and hold, it’s about picking up and dumping, and then doing it all again the next night (when the markets open of course).
Still, there is a kind of logic to this sometimes grotesque ritual, and while fashions change over time, there are always core imperatives that traders keep in mind. In the case of the Australian dollar versus the US dollar these imperatives include:
- global growth and commodity prices;
- domestic interest rates and how they stack up relative to the rest of the world;
- investor sentiment and risk appetite;
- technical indicators, which are the tools that traders use to determine price actions;
- and, of course, the issues on other side of the cross, i.e. the US Dollar.
The combination of these factors caused the local currency to head back to its recent high around $US1.05, even though the Aussie, in the words of the RBA,
“…remains at a high level by historical standards, with the nominal trade-weighted index almost at the multi-decade high recorded in early March, despite a deterioration in the global economic outlook and a decline in the terms of trade.”
That is code for the Aussie hasn’t gone down as many thought it would have or should have.
But although the single input of commodity prices is a significant driver of the Aussie’s value, while the pheromones are strong the only thing that matters is sentiment.
And while at Macro Investor we certainly hold the view that the pullback in global aggregate demand, commodity prices and, in particular, bulk commodities such as iron ore and coking coal, will matter, for the time being the music is playing, the liquidity is being drunk and these are problems for the morning.
Yet with every binge there is an equal and opposite hangover and eventually the spread between the AUD and commodities and the AUD and Australian government bond premiums will collapse.
For the time being, while interest rates in Australia are high relative to the rest of the world and while our banking and fiscal position, on the surface and including household debt, is so much healthier than the alternatives we are the prettiest girl in the room.
Add in a triple-A credit rating and the risk-adjusted return on holding Australian government bonds, something which has driven foreign ownership from 60% in 2009 to 76.5% presently, and we’re also safe enough to take home to mother.
But in the same way the Aussie has benefited from a positive feedback loop that drove it up to a high of $US1.1080 in 2011, once the table turns all this will be forgotten.
Already, over the past week, the Aussie has underperformed the risk rally in equities pulling back to $US1.04 rather than rallying up through $US1.06, contradicting its supposed "safe haven" status.
What is driving this is hard to tell, except perhaps that if this is a genuine risk rally in equities and nothing else, but equally there is now talk of rotation out of the Aussie and into other currencies, which have lagged over the past year. The heady scents of the Mexican Peso and the Turkish Lira are the latest, more exotic attractions.
Like the proverbial movie starlet who suddenly stops getting the calls, will we be dumped for nothing other than not being pretty enough? It seems this may have already happened as allocations to Australia have stopped increasing at a rising rate.
Large debt overhangs globally and a Chinese slowdown are questioning rosy price assumptions for commodities, which in turn threaten announced capital expenditure, such as at Yancoal yesterday. Likewise, this dynamic threatens the federal government’s budgetary position and the margins of our major banks, which have been selling into the rallies.
The world still loves the Aussie dollar it seems, at least psychologically, but its beauty is fading fast and in the cold light of day its value could easily diminish.
Greg McKenna is chief investment strategist at Macro Investor, Australia's independent newsletter covering shares, forex, fixed interest and property. He is the former head of currency trading at NAB and Westpac. Click here for a free, three-week trialto Macro Investor.