Currencies | Mar 05 2012
– More fund managers accumulating the Australian dollar
– This process is changing the currency's characteristics according to ANZ
– Implications from this for AUD investors going forward
By Chris Shaw
An old market adage for the Australian dollar is it goes up by the stairs but down by the elevator. This characteristic may be changing in the view of ANZ Banking Group, as the Australian dollar has been accumulated by global asset managers as they chase yield and acceptable levels of credit exposure.
Andrew Salter, ANZ's FX strategist, notes this has accorded the currency a premium as these fund managers chose the Australian dollar over the traditional G4 reserve currencies. This has pushed the dollar above the level implied by the terms of trade, as recently noted by the Reserve Bank of Australia (RBA).
There are implications stemming from the gains in the currency, with the portfolio re-balancing process a major factor according to Salter. With more fund managers accumulating the dollar managers they need make more transactions to keep their exposure within risk limit mandates.
This is even more likely given most recent capital inflows have come via portfolio debt, which Salter suggests should be re-balanced more frequently than would be inflows in the form of foreign direct investment.
This re-balancing means fund managers invested in the Australian dollar will buy the currency when it depreciates and sell it when it appreciates, a process Salter points out will trim other movements in the price of the dollar. Examples of this are the standard deviation, skewness and kurtosis of the currency. The latter is a measure of the “peakedness” of the dollar's probability distribution.
Looking at these measures, Salter notes standard deviation for the Australian dollar has always been higher than for other major global currencies for reasons such as liquidity and the size of current account deficits in Australia.
With a cyclical widening of the current account deficit expected over the next few years, the dollar should remain susceptible to similar flows as in the past, but Salter suggests a higher level of portfolio re-balancing should translate into a lower level of volatility.
Given this, Salter sees scope for the standard deviation of daily returns for the Australian dollar to fall from levels of around 12% recorded since its float in 1983 to closer to that of the 7-9% recorded by reserve currency pairs such as the EUR/USD and the USD/JPY.
A tendency for the Australian dollar has been to deliver negative skewness and negative excess kurtosis, which means the currency is more likely to fall by a large amount than rise by an equally large amount and small moves either way are more common than large moves.
But recently skewness has been returning to neutral levels and kurtosis consistent with a high number of returns close to the mean, which is what Salter would expect should the Australian dollar remain a major part of the portfolios of global fund managers.
While there is some evidence to back up Salter's theory, he cautions the potential for greater portfolio re-balancing in the spot market is still open to conjecture and may not in fact materialise. This is particularly the case as the effects have not yet become evident in recent data.
As well, Salter expects in the future there will still be periods of high volatility in the currency and times when there are significant changes in short periods. But for as long as the global credit market remains difficult and return on investment in developed economies remains poor, the Australian dollar should continue to be a beneficiary to at least some extent.
Assuming this leads Salter to suggest some implications for those investing in the Aussie dollar. One is for speculators looking for short, sharp downswings, these opportunities may prove to be less frequent in coming years.
For other currency managers expecting to enter a long position having missed the initial rally, the outlook would be more problematic assuming the character of the Australian dollar market develops as proposed.
As well, Salter suggests volatility could become cheaper, as the risk reversal shifts from a bid for the downside to more neutral levels and the butterfly should cheapen as the chances of tail events on either the long or short side decrease.
Technical limitations
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