Aussie Dollar Outlook- perfect storm for business.

February 7, 2012

FOREX

Here’s a question for you. What does a US job market recovery, low rates from the Fed, ECB, BOE and a rally in risk assets equal.

TROUBLE!

Trouble for Australian Manufacturing, trouble for Australian Tourism operators , trouble for Australian Universities and the outward facing education sector in general, trouble for Australian retailers, trouble for the RBA and trouble for the Australian government.

Why all this trouble? Well the easy answer is that in the current global environment and with the current global interest rate settings and economic settings stands out as a haven of relative safety. Against this backdrop the Aussie Dollar could fairly roar all the way to 1.15 and beyond.

You are probably asking why this is possible in a slowing economy with RBA rate cuts coming.

The simple answer is that markets are being set up for more asset inflation via quantitative easing in Britain, more spending by the ECB and the Fed’s commitment to low rates for the long-term.

It’s a recipe for a weaker US Dollar and because currencies are bilateral a stronger Aussie Dollar.

Bloomberg quoted John Taylor, the Head of the World’s biggest currency fund – FX Concepts, over the weekend saying that,

he’s betting against the dollar after Federal Reserve policy makers extended their pledge to keep interest rates close to zero and indicated they’re prepared to make additional asset purchases.

“I am shorter the U.S. dollar than I am the euro,” Taylor said…“We are going to have QE3 at some point and they stretched the time we are not going to have higher rates. That was a tremendous hit to the dollar. The dollar was doing fine until Bernanke came up with that idea…Everybody in the market is sure that whenever the dollar looks strong, Bernanke will come up with another idea to make it weak,” said Taylor

This policy of a weaker USD is explicitly aimed at benefitting the US and aiding its economy at the expense of other nations.

At the expense of Nations such as Australia, our businesses and our long-term economic future.

Now don’t get me wrong I am a strong supporter of the floating of the Aussie Dollar. I believe that it has been a most welcome shock absorber for our economy for the past 28 years. It fell and provided stimulus when necessary and rose to provide economic restraint. In many ways it was pro-cyclical with the direction of RBA rates do it worked to dampen the magnitude of RBA rate cycles.

But I don’t like the float much any more, well I still like it – prefer it actually to fixed rated and the troubles that brings, but the current and prospective strength is just too much.

Check out the chart below – it’s the Aussie Dollar over the past 5 years from Bloomberg.

See the big dip in the 2008/09 period when markets went into a funk that’s the shock absorber at work. The Aussie fell to 0.5960 because everyone was worried about the global economy falling apart, about China falling in a heap, about an end to Mining Boom part I and crucially, at the time, that the Australian Housing Bubble (not my words but the perceptions of offshore investors) would burst, and the RBA cut rates from 7.25% to 3%.

Pretty much everything in our Aussie Dollar toolkit and particularly when distilled to our 5 drivers was negative – so the Aussie went down. But after the pessimistic crescendo of early March 2009 ushered in a relief rally which then lead to the asset markets Fed and QE induced rally.

That’s ok, the Aussie rallied to the mid 0.90’s region before falling back again to 0.8050ish when we had the first round of European troubles in mid 2010. That is what I would consider to be normal moves for the Aussie. Before the fall I thought we’d get to 0.80 but that this would extend to 0.70.

We never got that low and QE2 changed the game again and this along with the fact that the Australian economy had not collapsed, that Mining Boom part 2 was on and the fact that the RBA was raucously cheer leading it contributed to offshore investors taking another look at Australia as an investment destination. And so it was that in late 2010 the Aussie started to break higher and last year, against the expectations of all policy makers, most pundits and certainly Australian business it broke and had held above 1.00 trading up to a high at 1.1080 mid last year.

It is currently 17 cents above the 200 week moving average of 0.90 even after being up here for a very long time. That’s tough for business – against the crosses the Aussie is similarly strong – Aussie Euro, Aussie Sterling, Aussie Kiwi. Against the history of the last 20 years and the long run average the current levels are even more starkly out of line.

For Australian businesses focussed on the domestic economy or exporting it’s a sad tale of Aussie dollar strength in a world where central bankers and elected officials are using their currencies to try to bolster their weak economies. You might argue that Germany wants to hold the Euro together so the Club Med south acts as a foil to the Teutonic North’s obvious attraction if the Deutschmark returned. thus Germany has a lower exchange rate than it should have.

Likewise the Fed is and remains committed in my view to keeping the USD as weak as possible without collapse, the Swiss called “time” and fixed their rate, the Chinese likewise are only allowing the renminbi to appreciate on their timeframe not what a free, or at least freer, float would demand. In the UK the BOE continues with its own quantitative easing, is allowing inflation to run at a higher pace than would have been elected – all the while keeping rates near zero.

And so Australia and our industry becomes the victim in the undeclared currency war of 2011-2012. Retail sales in 2011 were reported yesterday to have had the lowest growth since the mid 1980’s and who is surprised. I can buy things on Amazon landed on my desk often for less than half the price of a local purchase.

We are seeing the impact of this strong Aussie Dollar in the job losses recently. Whether it was Heinz in the Riverina, Aluminium workers in the Hunter, workers at Holden or even BHP Nickel the outlook is materially impacted by the high Aussie. Retail is one of Australia’s biggest employers, how long can it hold one without letting more people go?

But what can we do?

Can we fix the Aussie Dollar US Dollar rate? Of course we can. But I’m not a fan of fixed rates in a small open economy like Australia. We’ve been there and we’ll just end up with different pressures elsewhere.

Perhaps the RBA could start selling plenty of Aussie Dollars to feed the dogs while they are barking. We could build a Sovereign wealth fund by stealth in this way – swap our Aussie Dollars for relatively cheap foreign currencies of the US and China (maybe not Euro though) or other assets for the RBA portfolio. In this way we build national wealth and keep the Aussie lower than otherwise.

But where are all those Aussie Dollars going to go?

Into Aussie Dollar denominated assets is the most likely guess. So the pricing problem just gets transferred to another Australian asset or could potentially cause inflation as the money washes around the economy.

So maybe that’s not such an easy fix after all.

Could this RBA selling Aussie Dollars miraculously generate foreign currency that can then be lend to the banks to reduce their requirement for offshore borrowings as some have argued? Yes of course, but that still needs to be paid back to the RBA at some point so it is just an accounting equation and doesn’t help, in fact I’d argue may hinder, the overall economy as the Aussie Dollars float around the system or indeed become short-term deposits in the Australian Banking system by foreigners and replace long-term investments by foreigners.

So it could actually change the current reliance on long-term foreign investors to deposits that are short-term in nature and thus prone to flight. Kind of an anti Basel III solution and Macro prudential regulation this s not!

My answer is simple – decide as a nation what industries we see s strategic and support them. Food security, manufacturing security, education, tourism. For those industries we can’t help avoid change, say retail which is as much technological in my view as currency related, we need to build replacement industries.

There is enough wealth being generated at present in the mining boom for the state to take a share. Is this wealth really best allocated to media assets? Australia should have a proper debate about how to harvest the wealth being generated by miners selling Australia’s finite assets and paying little more than a parking fee for them.

Why should we do this?

Because the Aussie Dollar could be on its way to 1.15, 1.20 and beyond if we get the kind of benign markets we saw in 2010 which ignited the Aussies rally. Low rates, governments actively weakening their currencies and more QE is a perfect storm for the Aussie – 2012 could be the year.

But even if it’s not headed to the moon we are already seeing the Aussie Dollar’s strength hollowing out industry and the bifurcated nature of the economy both now and in prospect is narrowing Australia’s productive base. Surely that can’t be good for anyone.

We need to engage our political and policy making class as to the risks of the current strategy of benign neglect with regard to the Aussie Dollar’s strength and we need to support our industry.

Treat this Aussie strength like we do a drought in the bush – support our industry until the Aussie turns tail and falls once more. And fall it will because a lot of the Aussies strength is simply the fact it’s currently a safe port in the global economic and market storm. Storms pass, the global economy will heal in time and investors will sell their Aussie Dollars and take them elsewhere once more.

Lets make sure we have industry left to take advantage of our natural stabiliser when this happens once again and the Aussie Dollar falls.

Have a great day

www.twitter.com/gregorymckenna

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation

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2 Comments on “Aussie Dollar Outlook- perfect storm for business.”

  1. shane Says:

    Very eloquently put GM.

    Reply

Trackbacks/Pingbacks

  1. How high can the Australian Dollar go? | Lighthouse Securities - February 14, 2012

    […] You may ask why I’m pushing this theme again when I was on it earlier in the week. […]

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