Currencies | Feb 13 2013
-AUDUSD strength to stay
-Many factors are supportive
-Less volatility around
-Foreign investment robust
By Eva Brocklehurst
Those wishing for an end to the Australian dollar's strength may have to wait a bit longer. Commonwealth Bank thinks this year the currency will continue to hold up against the US dollar and forecasts US$1.07 by June. The bank's strategists see a soft US dollar remaining hampered by fiscal contraction. Furthermore, the US Federal Reserve has maintained an ultra-loose monetary policy stance and as a result US real interest rates should remain negative for an extended time.
In contrast, the outlook for the broader Asian economy, specifically China, continues to improve and this spells strength for the local currency on a fundamental basis. CBA believes Asia should remain the driver of global growth and hence Australia's economic prospects. Australia sends around 76% of its exports to Asia and iron ore and coal account for 38.6% of merchandise exports. Reliably supportive is Australia's huge iron ore and coal production capacity, a by-product of substantial investment over recent years. CBA highlights the size of China's economy as the real reason to be bullish on this score. Here, it's not about China's GDP but about the size of its demand. CBA estimates that at the end of 2012 the Chinese nominal economy was 3.8 times larger than in 2003. The analysts also think foreign direct investment flowing into property and mining in Australia will continue. There is a large portion of this holed up in the LNG sector, where the development timeframes are long.
There are other factors supporting the Australian dollar that are less well flagged. Foreign central banks have been diversifying foreign exchange reserves into Aussie dollars over recent years, and CBA does not expect this trend to go into reverse any time soon. Non-Japan Asian currencies are expected to remain strong and, consequently, Asian central banks are likely to maintain a degree of diversification into the Australian dollar. We're also not going to return any time soon to high volatility in foreign exchange trading. CBA notes the increased liquidity in the global financial system, and proactive stance of the major central banks, should keep measures of market volatility relatively benign. The days of traders taking a position against central banks are in the past, for now at least.
While concerns have been raised about foreign holdings of Australian Commonwealth Government Securities (CGS), currently at 77%, CBA notes the rate of growth has slowed. Nevertheless, absolute investment levels remain high, and there is scope and demand for other Australian dollar denominated securities. Another factor supporting investment in local debt is that the pool of AAA-rated sovereigns continues to decline. CBA notes, on the S&P ratings scale, Australia remains one of just fourteen AAA-rated sovereigns, or just one of eight if you take into account a stable outlook. Overlay this with relatively higher interest rates and the risk-adjusted return on Australian assets remains high. CBA thinks Australia's relative yield advantage will remain in place for some time.
Given the hype about Europe's sovereign debt crisis it's perhaps surprising to find Australia's currency is underperforming against the euro. In Commonwealth Bank's view, this stems from a reduction in euro short positions as well as Asian currency weakness. In this case, the Australian dollar is being used as a proxy by traders for non-Japan Asian currencies. The recent weakness in non-Japan Asian currencies was brought on by a sharp depreciation in the yen and this, by implication, weighed on the Aussie. CBA believes a rebound is likely, given Asia's positive fundamentals. This, again, is why the bank's outlook is so positive on the Australian dollar.
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