Currencies | Dec 11 2012
-Leveraged currency trades muted
-Real money still active
-Economic growth differentials key
-Australian dollar firm
By Eva Brocklehurst
ANZ Bank foreign exchange analysts cast a net for the coming year and dredged up a weak US dollar, strong Asian currencies and a continuation of the Australian dollar's robust performance. Then, after a week seeing clients in North America, the ANZ view met some resistance.
ANZ proffered the view that the large de-leveraging flows into the treasury market – US$2 trillion since the financial crisis began – would likely ease, as pressure on private sector balance sheets moderated, causing the US dollar to trade poorly. However, most of those clients ANZ discussed this prediction with had a strengthening US dollar outlook, at least against the G10 currencies. Why? It's all in the nature of comparable economic growth. For European-linked currencies domestic considerations were the main drivers of that view (such as weak growth and more quantitative easing). ANZ noted that, for the US currency, there was actually little focus on the treasury flows or the US deficit, with a stronger US dollar view appearing to be almost entirely based on growth differentials. Here, ANZ admits the US growth cycle does appear to stand out as strongest among the G4.
Euro stability – the currency seems to be closing the year at around the same level as it started – is a reminder, ANZ noted, that picking the correct framework in foreign exchange is at least as important as picking the macro economic surroundings. In this case ANZ analysts were also struck by a notable division in the risk appetite of real money and leveraged investors. Real money appears to have the appetite to take active investments, while leveraged investors have scaled back their activity significantly as the year ends. There was a sense that the longer investment timeframe afforded to real money accounted for part of this divergence. In other words, patience is seen rewarded. Of the two, leveraged investors gave the ANZ view the biggest run for their money. ANZ sees the euro as not a strong currency, but a meaningful current account surplus and some stabilisation in the growth profile will be sufficient for modest strengthening. Anything which reduces eurozone break-up risk is considered euro positive.
On the Australian dollar, ANZ mounted the case for continued strength from record foreign direct investment flows. However, attention offshore was centred on bond flows and the diversification trade. ANZ finds this a bit perplexing as bond flows have tailed off now and foreign direct investment is actually dominating the capital account. That said, ANZ noted that positioning amongst leveraged money on the Australian dollar appears to be quite muted, with the local currency's stubborn price action no doubt frustrating for them. Supporting this view, there was little focus on potential RBA intervention. For real money, ANZ sensed investors were short against the benchmark, with valuation, RBA rate cuts and the peak in the mining boom all key elements in trading.
Asian currencies in the discussion net were the Chinese yuan, the Indian rupee and the Japanese yen. ANZ notes foreign ownership is not high and the region is investing more in itself, which reduces vulnerability to external capital. Few currencies were considered expensive.The Indian rupee and the Taiwan dollar are likely to remain laggards in ANZ's view but the rupee was generally viewed positively by the North American client contingent. Its underperformance relative to its peers (although in real terms ANZ considers it has not underperformed) and signs that the government is more intent on a credible reform program, appear to be the key drivers of a positive view. With foreign ownership of India's bond market only 3.5%, because of regulatory restrictions, there is still broad-based interest in India as a destination for increased investment allocation.
ANZ expects modest spot appreciation for the yuan, but volatility is low, carry trades favourable and the risk of depreciation low. Meanwhile, the yen needs a revolutionary domestic monetary policy response to drive sustained depreciation. That's unlikely, according to ANZ. Most indicators suggest that locals are net yen buyers, which should keep the currency strong, and monetary policy is relatively tight. Also, unexpectedly, ANZ found quite mixed views in North America on US dollar-yen. The dollar bulls emphasised an expected shift in monetary policy, while others cited the institutional constraints to such a shift. However, while bulls tended to be quite convinced, others were more circumspect rather than outright bearish.
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