Market Thinking

making sense of the narrative

Aussie Dollar moves from Commodity to Currency

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The following is based on an article submitted to the Australian Financial Review for this weekend. As such it obviously has an Australian angle, but one that is also important for investors understanding how the new RCEP trade bloc is also going to transform the way capital flows in the Asiatic region and the new role that the Yuan and currencies like the AUD will play

Australians are understandably more focussed on their currency exchange rate than are the citizens of most other countries, except perhaps the British. Partly this is because of the open and trading nature of the economies and partly because they can easily be the most volatile part of anyone’s investment portfolio. Indeed, I recall it was very difficult to persuade any of the institutional investors in Australia to invest in a global equity fund between 2006 and 2008 on the basis that over that period the Aussie Dollar appreciated around 38% against the dollar so that in local currency terms it was almost impossible to beat a simple investment in Aussie cash, let alone equities. It’s a little trade secret that some of the best performing ‘Global Equity Funds’ in the Australian market at that time did so on account of not actually having much global equity exposure! The GFC wiped out all those gains in a matter of months of course, as the world saw a flight to safety, meaning that the dominant international investors (the US) took their dollars home. However, pretty soon the process started again, but this time the Aussie Dollar move was turbo-charged by the China effect as the Chinese economic stimulus from 2009 sucked in huge amounts of imports from Australia, not only coal and iron ore but also agriculture and services such as tourism and education. As such between 2008 and 2011 the Aussie dollar rose 80% against the US$,  ultimately going up through Parity at one point and once again making it very difficult to persuade anyone to invest offshore.

Australian Dollar has moved more like a commodity than a currency

Source Bloomberg. Market Thinking

Against this background, the breathless commentary on a daily basis that (to quote Bloomberg this week ) “the Aussie dollar declined 0.2% to 0.7520 after climbing as much as 0.2% earlier” seems very prosaic and serves to remind us that the majority of the Foreign exchange (FX) markets operate on huge leverage attached to tiny daily movements. Perhaps uniquely, the Aussie dollar is almost like a commodity rather than a currency, especially now since the rise of China. Indeed, post 2011/12 what we actually began to see was the Aussie dollar starting to track the Chinese economy and in particular its Industrial production and purchasing manager data much more than it tracked any of the traditional domestic economic and monetary indicators. As such through 2013/15 it began, once again, to unwind its relative performance against the US$, especially as the Chinese stock market sold off in 2015, before, in true cyclical fashion, staging a decent 17% rally in 2016/17. Then, again true to form, it began  rolling over once more in early 2018 before being hit by a 2008-style flight to safety in March of this year which took the currency all the way back to the 2008 lows. The question now is, having rallied over 30% from those March lows, have we seen the end of the latest cyclical rally against the dollar, or are we less than half way there?

In seeking to answer this question it is important to remember that exchange rates are just relative prices and that what may be seen as strength from the Australian side may alternatively be seen as weakness from the US side. Thus, the fact that the dollar trade weighted index has been slipping steadily since its flight to safety highs back in March suggests that almost ‘everyone’ has been rallying against the US $ and raises the question as to whether there might actually be an active depreciation policy at work in the US. If so then it should be the turn of the international investors to get offshore in the way the Aussie funds did from 2013 onwards. Certainly, if we take a three-year view for both the Aussie dollar and the pound sterling against the US $, we can see that they are both back to where they started, sterling having dropped 15% and the Aussie $ 25% in the meantime and technically both are looking strong against the greenback, the Aussie more so. 

The huge Regional Comprehensive Economic Partnership (RCEP) trade deal announced last month which effectively links the ASEAN countries with Australia and New Zealand in the South and the three industrial giants of China, Japan and South Korea in North Asia will only help to solidify the Australian dollar as an important regional trading currency – despite the current spats over coal imports. On that basis it is interesting to note that for all the volatility against the US$, if we exclude the extreme movements around March then we see that the Australian Dollar has traded in a relatively narrow band (broadly 4.75 – 5) against the offshore Yuan, the currency that is going to be the one that really matters going forward. So yes, it may well be that the Aussie $ is only half way through its appreciation cycle against the US$, but then so too is the Yuan and it remains to be seen whether either China or the US are going to be happy about that.

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