Australia | Sep 22 2006
By Chris Shaw
Just like profit reporting season when it is how a result matches against expectations and outlook comments that drives a share price more than the result itself, foreign exchange markets can be driven by factors such as momentum as much as by underlying fundamentals.
Chief economist Stephen Koukoulas of TD Securities makes this case when forecasting a period of outperformance by the Australian dollar in relation to the Canadian dollar in coming weeks and months.
He notes this trend has been in evidence in the past few days as the Aussie dollar has done well against both the Canadian and Kiwi dollars, while also pointing out a few reasons why such a pattern can be expected to continue.
Momentum is one, as Koukoulas notes while Canada has a current account surplus Australia is running a deficit of more than 5% of GDP and in New Zealand it is almost 10%. Economic theory suggests this should be supportive for the Canadian currency, but the market is saying otherwise. Koukoulas points out this is because the surplus in Canada is falling while the deficit in Australia is shrinking, meaning the market is looking at the future rather than the actual numbers when assessing the likely directions of the respective currencies.
Adding support to this theory is the outlook for each country in trade terms as while Canada sends 85% of its exports to the US, where a slowdown appears to be underway, Australia sends a significant portion of its exports to Asia where growth remains strong. Even assuming a US slowdown impacts on the Asian region Australia still looks to be better placed in comparison to Canada, something that will eventually be reflected in their respective currencies.
Interest rates are also a factor, as while the next move in rates domestically is likely to be an increase (with the market factoring in a further 0.25% hike by the end of the year) the opposite is likely in Canada, Koukoulas expecting a series of cuts to rates over the course of 2007. This of course impacts on the relative attractiveness of the two currencies, as the interest rate differential would likely increase to more than 2%, which would support a flow into the Aussie and out of the Canadian dollar.
Koukoulas is recommending investors buy the Australian dollar against the Canadian currency, as from current levels of around 85.2 he sees a move to around 90.0 as likely. With the economic outlook in New Zealand less positive, Koukoulas recommends selling the Kiwi dollar against either the Aussie or US dollars on any rallies.