Currencies | Apr 09 2013
– Central banks switching into less traditional currencies
– Aussie greatly favoured
– Yen funds flowing into Aussie
– Canadian pension funds still buying Australia
By Greg Peel
The Australian dollar has long been considered a “commodity currency” yet despite ongoing weakness in commodity prices over the past many months the Aussie simply refuses to fall below parity with the US dollar, causing heartache to many Australian business sectors.
The “commodity currency” label represents a link through to the Australian GDP. Strong commodity prices suggest strong economic growth, and strong economic growth ultimately results in the RBA raising its cash rate. The resulting improved interest rate differential attracts offshore investment in government bonds and listed equities, forcing the exchange rate higher, although the exchange rate moves swiftly in anticipation of eventual RBA policy changes. The reverse thus should also be true.
But it hasn’t been, despite 125 basis points of RBA rate cuts over the past 18 months.
One factor ensuring a persistently strong Aussie is the ongoing flow offshore funds into fully owned or joint venture resource projects, which again requires a switch into the local currency. Mining capex is now peaking but it could be two to three years before LNG project funds flow peaks and falls. In the meantime, with interest rates at or near zero in all developed world “safe” economies, the RBA would have to cut its cash rate substantially to finally scare off foreign investment into Australian securities.
This reality is evident in a recent survey of 60 central banks conducted by Central Banking Publications and the Royal Bank of Scotland, which represents some US$7 trillion of reserves under management, the bulk of which is held by Asian and Middle Eastern monetary authorities. Primarily in an attempt to curb their own currencies’ gains, these authorities are invested predominantly in US government debt and the debt of safer European sovereigns. But with rampant money printing under way across the developed world, these traditional assets are providing less and less return.
Such low returns are forcing diversification, and diversification implies a shift up the risk scale to smaller or emerging market economies. The survey found 80% of respondents had already invested in, or would invest in, the Australian or Canadian dollars. Around 50% said they had, or would consider, investment in the Scandinavian currencies and the New Zealand dollar. Over 40% have or would move into the renminbi, and likewise 14% for the Brazilian real.
Just to indicate how serious the situation has become, 30% of respondents suggested they would probably buy equities as well as government bonds, albeit not in the immediate term, which flies in the face of nature when it comes to central banks and risk.
What the survey does suggest is that until we see a turnaround in developed world interest rate policy to a less accommodative stance, and right now that seems a long way off, the Aussie dollar will remain supported whether we like it or not. A serious commodity price collapse should affect a break below parity, but that is not what we want either.
Meanwhile, yesterday the Bank of Japan began making its first purchases of Japanese government bonds as part of its massive stimulus program and the yen continues to fall, now down some 25% against the US dollar since it became clear last year Shinzo Abe would win the election. As funds flow out of the yen, where are they headed?
“The asset allocation shift out of Japan is pretty dramatic and that’s really what’s driving the market now,” noted Jens Nordvig, global head of currency research at Nomura, last night. “The yen is the main mover but it clearly does matter where you’re putting it as well. The institutional flow could be quite Aussie-focused,” he suggested.
Back on the home front, the flow of Canadian pension funds into Australian infrastructure assets continues unabated. Having already invested heavily in domestic infrastructure, the Canadian funds have been forced to look further afield and according to Australian trustee The Trust Company are increasingly focusing on property and infrastructure investments in Australia, with the Australian market’s attractive yields, high quality assets and proximity to Asia the main drawcards.
"These funds are looking for stable, cash flow generating assets that can be held for the long term, with returns that are not highly correlated to share markets," said Andrew Cannane, Trust Company General Manager Corporate Clients, in a press release yesterday.
"Coupled with Australia's reputation as a safe investment haven, its robust regulatory regime, the relative strength of the Australian economy, and the attractive yields of property and infrastructure assets relative to international markets, Australian infrastructure ticks all the boxes.
"On a relative risk weighting Australia is still a most attractive investment destination for these pension funds. We would expect to see many of them continue to build out their platform in Australia in the years ahead," Cannane concluded.
Yesterday General Motors Holden announced the sacking of 500 workers from the most heavily government-subsidised manufacturing industry in the country, with the strong Aussie and subsequent lack of competitive pricing the major excuse. Once the devalued yen flows through to manufacturing, Toyotas and other Japanese vehicles will be cheaper than ever before.
There appears no end in sight to an inflated Aussie dollar, no matter how many analyst models suggest the currency is overvalued.
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