The Australian Dollar has lost nearly 1/3 of its value (relative to the USD) over the last few months, as the credit crisis continues to drive investors away from areas perceived as risky. In other words, the best (and perhaps the only reasonable) explanation for its fall has very little to do with Australian economic
fundamentals. Then again, the rise in the currency that took place over the last decade was also rooted in technical and financial trends, although rising commodity prices were also a factor. The Australian Dollar (as well as the New Zealand Kiwi) was one of the prime beneficiaries of carry-trades, due to unusually "generous" interest rate levels. Now that investors are chasing stability/capital preservation instead of yield, however, the currency has seriously fallen out of favor. The Australian reports:
Equity markets would continue to drive currency markets, while being influenced by the ongoing financial crisis. "These are unprecedented times in volatility for the Australian dollar and currencies," said [one analyst].
AUD Continues to Dive
On the basis of technical factors, the Australian Dollar had halted its precipitous decline against most major currencies. As a result of an unbelievable 100 basis point interest rate cut, however, the currency has resumed its fall. That the rally was short-lived is not a mystery. The yield advantage enjoyed by Australia over the last few years has almost completely evaporated. Combined with lackluster Australian equity performance and tanking commodity prices, foreign investors have little reason to maintain capital in Australian holdings. On the plus side, the rate cut showed investors how serious Australian economic policy-makers are in dealing with the credit crisis. Unfortunately, diligence doesn't always translate into efficacy.
Australian, New Zealand Currencies Benefit from Risk Aversion
Against each other, the New Zealand Kiwi and Australian Dollar have traded in a pretty tight range for the last year (except for a “blip” in the fall of 2008). This makes sense, as both currencies rise and fall in accordance with exports and interest rates.
Reserve Bank of Australia Could be the First to Hike Rates
Based on the chart below, which plots the Australian Dollar against the New Zealand Dollar over the last two years, one might be tempted to conclude that the two currencies are identical for all intents and purposes. Rather than suffer the inconvenience of separately analyzing the Australian Dollar, why not just read yesterday’s post on the New Zealand Dollar, and leave it at that?
Australian Dollar Rises, Remains Closely Correlated with Stocks
The performance of the Australian Dollar over the last six months has been nothing short of incredible: “Since the end of February, the Australian dollar has risen 29% against the U.S. currency,” and a still-impressive 18% if you backtrack to January, when the Aussie was still in free-fall.
Kiwi and Aussie Diverge, then Re-Unite
Over the last few months, the New Zealand Dollar and Australian Dollar have largely moved in tandem (see chart below). When the Reserve Bank of Australia raised its benchmark interest rate earlier this month, it shocked the markets and the Aussie shot up, while the Kiwi remained fixed in place. Many observers predicted that such was the beginning of a divergence in the two currencies. Less than one week later, however, the New Zealand Dollar hitched itself back to the Australian Dollar, and the two currencies have since traded in lockstep.
Pause in Rate Hikes Threatens AUD
In October, the Reserve Bank of Australia (RBA) became the first industrialized Central Bank to raise interest rates. It followed this up with two additional hikes in November and December, bringing its benchmark rate to the current level of 3.75%, by far the highest among major currencies.This series of rate hikes caught (forex) markets completely off guard, and investors moved quickly to price the changes into securities and exchange rates. The Australian Dollar initially spiked more than 7% following the first rate hike, bringing its total appreciation in 2009 to 32%- enough to earn it the distinction as the second-best performing currency, after the Brazilian Real. Beginning in November, however, concerns began to build that perhaps traders had gotten ahead of themselves, and the AUD has been in freefall since then.
Australia Dollar Ebbs and Flows with Risk
If you chart the course of the Australian Dollar over the last twelve months alongside the S&P 500, the overlap is jarring. You can see from the chart below that the two lines zig and zag in almost perfect unison. It would seem that there was a slight break in the second quarter of 2010, but even this is an illusion, since the Aussie and the S&P continued to rise and fall in the same patterns over that time period, differing only in degree of fluctuation.
Betting on China Via Australia
There are plenty of investors that think betting on China is as close to a sure thing as there could possibly be. The only problem is that investing directly in China’s economic freight train is complicated, opaque, and sometimes impossible. The Chinese government maintains strict capital controls, prohibits foreigners from directly owning certain types of investment vehicles, and prevents the Chinese Yuan from appreciating too quickly, if at all. For those that want exposure to China without all of the attendant risks, there is a neat alternative: the Australian Dollar (AUD).
Those of you that regularly read my posts and/or follow the forex markets closely should be aware of the many correlations that exist between currencies and other financial markets, as well as between currencies. In this case, there would appear to be a strong correlation between Chinese economic growth and the Australian Dollar. If the Chinese Yuan were able to float freely, it might rise and fall in line with the AUD. Since the Yuan is fixed to the US Dollar, however, we must look for a more roundabout connection. HSBC research analysts used Chinese electricity consumption as a proxy for Chinese economic activity (why they didn’t just use GDP is still unclear to me), and discovered that it fluctuated in perfect accordance with the Australian Dollar.
Can the Australian Dollar Hold on to Record Gains?
The volatility of the last couple weeks has manifested itself in some unbelievable outcomes. In this post, I want to focus specifically on the Australian Dollar. When the Japanese disasters struck, the Aussie immediately tanked, as investors jettisoned risk and moved towards safe haven currencies. Only days later, it inexplicably rose 5%, en route to parity and a 28-year high against the US Dollar. The question is: will the Aussie hold on to these gains, or will it return to earth as soon as the markets come to terms with the misalignment with fundamentals?
Aussie is Breaking Away from Kiwi
The correlation between the Australian Dollar and New Zealand Dollar is among the strongest that exists between two currencies. Given their regional bond and similar dependence on commodities to drive economic growth, perhaps this is no wonder. Over the last year, however, the Aussie has slowly broken away from the Kiwi. While the correlation between the two remains strong, the emergence of distinct narratives has given rise to a clear chasm, which can be seen in the chart below. Given that the NZD is evidently among the most overvalued currencies in the world, does that mean the same can be said about the AUD?
Why is the Loonie Beating the Aussie?
It sounds like the beginning to a bad joke, right? But seriously, why is the Canadian Dollar (aka Loonie) beating the Australian Dollar (AUD) when the two currencies are placed head-to-head?
The currency markets tend to be very Dollar-Centric, in that they tend to view most currencies relative to the
US Dollar (and to a lesser extent, the Euro), rather than to each other. When it comes to the Aussie and Loonie, then, traders at the moment seem content to see them as relatively strong, since both are appreciating against the Dollar. After all, the AUD/CAD pair accounts for only a small fraction of overall trading activity, which means that liquidity is lower and spreads are higher. Why bother?
But this ignores the fact that an important battle is currently being waged by the two currencies not only against the Dollar, but also against the other. It’s not as if the AUD/CAD rate is determined solely based on triangular arbitrage (i.e. indirectly from the AUD/USD and USD/CAD). On the contrary, there are unique factors which determine this exchange rate irrespective of others, as well as specific financial instruments.
But enough with the palavering!Let’s try to understand the idea of parity as it exists between the Loonie and Aussie, and not relative to the Greenback. I like to begin any analysis by looking at a chart. But as with any financial chart, a different time period changes the whole picture. In this case, the 1-year chart shows the Australian Dollar gaining in 2009 (in fact it was the highest performer last year among all of the majors) from the lows of the credit crunch, but retreating in 2010 away from parity. It is this latter trend that I want to elucidate here.
Betting on China Via Australia
There are plenty of investors that think betting on China is as close to a sure thing as there could possibly be. The only problem is that investing directly in China’s economic freight train is complicated, opaque, and sometimes impossible. The Chinese government maintains strict capital controls, prohibits foreigners from directly owning certain types of investment vehicles, and prevents the Chinese Yuan from appreciating too quickly, if at all. For those that want exposure to China without all of the attendant risks, there is a neat alternative: the Australian Dollar (AUD).
Those of you that regularly read my posts and/or follow the forex markets closely should be aware of the many correlations that exist between currencies and other financial markets, as well as between currencies. In this case, there would appear to be a strong correlation between Chinese economic growth and the Australian Dollar. If the Chinese Yuan were able to float freely, it might rise and fall in line with the AUD. Since the Yuan is fixed to the US Dollar, however, we must look for a more roundabout connection. HSBC research analysts used Chinese electricity consumption as a proxy for Chinese economic activity (why they didn’t just use GDP is still unclear to me), and discovered that it fluctuated in perfect accordance with the Australian Dollar.
Can the Australian Dollar Hold on to Record Gains?
The volatility of the last couple weeks has manifested itself in some unbelievable outcomes. In this post, I want to focus specifically on the Australian Dollar. When the Japanese disasters struck, the Aussie immediately tanked, as investors jettisoned risk and moved towards safe haven currencies. Only days later, it inexplicably rose 5%, en route to parity and a 28-year high against the US Dollar. The question is: will the Aussie hold on to these gains, or will it return to earth as soon as the markets come to terms with the misalignment with fundamentals?
Aussie is Breaking Away from Kiwi
The correlation between the Australian Dollar and New Zealand Dollar is among the strongest that exists between two currencies. Given their regional bond and similar dependence on commodities to drive economic growth, perhaps this is no wonder. Over the last year, however, the Aussie has slowly broken away from the Kiwi. While the correlation between the two remains strong, the emergence of distinct narratives has given rise to a clear chasm, which can be seen in the chart below. Given that the NZD is evidently among the most overvalued currencies in the world, does that mean the same can be said about the AUD?
Aussie May Have Peaked in 2010
When offering forecasts for 2011, I feel like I can just take the stock phrase “______ is due for a correction” and apply it to one of any number of currencies. But let’s face it: 2009 – 2010 were banner years for commodity currencies and emerging market currencies, as investors shook off the credit crisis and piled back into risky assets. As a result, a widespread correction might be just what the doctor ordered, starting with the Australian Dollar.
By any measure, the Aussie was a standout in the forex markets in 2010. After getting off to a slow start, it rose a whopping 25% against the US Dollar, and breached parity (1:1) for the first time since it was launched in 1983. Just like with every currency, there is a narrative that can be used to explain the Aussie’s rise. High interest rates. Strong economic growth. In the end, though, it comes down to commodities.
Risk Aversion Hits Australian Dollar
These days, I feel like you could take that title and substitute pretty much any currency for the Australian Dollar. Let’s face it- the EU sovereign debt crisis has hit a number of currencies extremely hard, as investors have fled anything and everything risky, in favor of the US Dollar, Swiss Franc, Japanese Yen, and Gold.
Still, the Australian Dollar merits special attention, because in the forex markets, it has come to be a symbol of risk-taking. For veritable years, every credit expansion and economic boom has been accompanied by a surge in the value of the Aussie, and 2009 was no exception. As the global economy recovered and risk aversion ebbed, the Australian Dollar rose by more than 40% against the USD. It has been helped in its upward course by Chinese demand for its natural resources and strong interest rates, especially compared to the rest of the industrialized world.
Canadian Dollar Slated to Outperform Other Commodity Currencies
In the same vein as Monday’s and Tuesday’s posts (covering the New Zealand Dollar and Australian Dollar, respectively), I’d like to use today’s post to look at another commodity currency – the Canadian Dollar. The Loonie, it turns out, has also benefited from the a recovery in risk appetite and concomitant boom in commodity prices; it has appreciated by 7% against the USD in the last month alone, en route to a ten-month high. “All in all, with almost everything going its way these days (besides the crummy weather and the impact on tourism), a return trip to parity – last visited nearly one year ago – doesn’t seem far fetched,” chimes one optimistic analyst.
New Zealand Dollar Rise Threatens Economic Recovery
Having risen nearly 30% against the US Dollar since March, the New Zealand Dollar (NZD or Kiwi) is now close to a 9 1/2 month high. While still far from the record highs of 2008, the currency is already erased a large portion of the losses it racked up since the credit crisis gave way to economic recession.
As part of last Friday’s coverage of the Japanese Yen, we included a chart which compared the performance of the AUD/JPY cross to the S&P 500. Even without calculating the correlation coefficient, a cursory review of the chart revealed an uncanny relationship! Unsurprisingly, it turns out the same relationship also applies to the New Zealand Dollar, whose recent performance closely mirrors US equities
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