FYI | Sep 11 2007
By Chris Shaw
Following disappointing labour market data for the US economy last week the market is becoming increasingly convinced growth in the world’s largest economy is weakening, meaning the Federal Reserve will be forced to lower official interest rates.
This implies what started as an issue in the sub-prime credit market has widened to the economy as a whole, leading markets to pre-empt the expected rate cuts by marking down the US dollar in recent sessions.
According to ANZ Bank senior currency strategist Tony Morriss the major beneficiary during this period has been the Japanese yen, as the fear of lower global growth has caused the carry trade to be unwound as investors bring money back to core markets.
With rates likely headed lower in the US Morriss suggests foreign exchange markets will increasingly be driven by interest rate differentials, at least until the scope of any interest rate easing in the US becomes clear.
Such a scenario is supportive for the Australian dollar against the US currency given the 2-year rate differential is now 240 basis points, the largest the spread has been since October 2004.
To date this support has not been apparent as the currency has traded in a relatively narrow range of US81.10-83.10c, but Morriss expects a break through these technical levels would see the currency move towards the longer-term range of US80-84c.
Against other currencies he sees the continued focus of investors being one of risk aversion, with the risk against the yen and other carry crosses remaining in favour of additional moves to the downside given the scope for further equity market weakness.
At the same time this risk aversion has worked in the Australian dollar’s favour against its New Zealand counterpart, the Kiwi dollar remaining even more exposed in the event of carry trade unwinding.
While suggesting the rally has been a little overdone Morriss expects the breaks above previous highs of this year’s high of NZ$1.148 and the late 2006 peak of NZ$1.1660 to now act as support levels, with potential for a medium-term move to as high as NZ$1.2450.
Again it will be rate differentials working in the Aussie dollar’s favour in coming months, Morriss pointing out the latest economic data show a still strong Australian economy that suggests rates will stay on hold, while a weakening of data coming from across the Tasman offers scope for rate cuts in coming months.
