Aussie Dollar dives like a ‘falling knife’

Dollar dives like a ‘falling knife’

May 17, 2013 – 3:39PM

Glenda Kwek

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On the way down … the Australian dollar over the past 10 trading sessions. In just 10 days, the Australian dollar has fallen from US103¢ to US97.4¢. The sudden fall has been so sharp one currency strategist described it as a ”falling knife”. The dollar has now fallen for five weeks in a row, and is on track for its worst weekly fall this week since November 2011. So what’s been driving the recent drop, and should we expect a rebound any time soon, if at all? Australian dollar … commodity price trends suggest that the currency should be trading closer to 80 US cents than parity, Goldman Sachs analysts say. In short, the first trigger was the sudden rallying of the US dollar against the yen and other currencies last Thursday night in New York. The US dollar broke through the significant psychological barrier of 100 yen and sent its Australian counterpart into free fall. That pushed the dollar past its own psychological barrier of US101.50¢ and it didn’t take long for the currency to drop through parity on Friday night. The Australian currency continued to fall over the past week, while the greenback has kept strengthening. This is not the first time the Australian dollar has broken out of the 102 to 106 US cents range it has been mostly trading in over the past two years. In September 2011 and May 2012, the currency fell below parity with the US dollar but lifted again shortly after.

Turning point

But currency strategists said the Australian dollar appeared to have reached a turning point, and talk of it bouncing back to above-parity levels was looking less likely.

”The big difference between this fall and the falls in the last couple of years is that they were driven by risk aversion, big falls in asset prices and global growth confidence associated with the European currency crisis,” RBS currency strategist Greg Gibbs said.

”This time, the Australian dollar has fallen in a risk-positive environment, and in some ways, it makes it feel more permanent.”

As optimism grows about the US economy amid growing expectations the US Federal Reserve could wind back its ”quantitative easing” money-printing strategy by the end of this year, investors were once again turning to other fundamentals that drive the Australian dollar, such as the Chinese economy, commodity prices, and the mining investment outlook, Mr Gibbs said.

And all of these indicators have been weak of late.

Stars align for drop

”Iron ore since the peak in February of this year … has lost a fifth of its value. Importantly, coking coal prices have weakened fairly significant too. The spot price of coking coal from the highs in February has dropped by 18 per cent,” Westpac chief currency strategist Robert Rennie said.

”When two or our key export commodities – coking coal and iron ore – lose a fifth of their value, that obviously implies that we should see some weakness in the currency.”

Mr Gibbs said investors now viewed the Australian dollar as reconnecting with commodity price movements.

The Japanese selling of the Australian dollar has also been weighing it down. Japanese investors were net sellers of Australian bonds last year – the first time since 2005 – while becoming record buyers of European bonds.

Given Japan’s influence in the debt market – where it contributes about 10 per cent of all portfolio investment in debt securities, the sell-off could also lower the dollar, HSBC analysts said.

Also fuelling the recent lows are the federal government’s announcement of budget deficits in the next few years, soft domestic economic indicators and the imminent peak of the mining investment boom, Goldman Sachs analysts said in a research note, adding they had reduced their 12-month Australian dollar forecast to 90 US cents.

No longer a safe haven?

At the same time, another change is occurring.

The Australian dollar, along with commodities such as gold, has functioned as a safe haven amid the global economic turmoil over the past few years. They have provided an avenue for higher yield as compared to other investment assets.

But as the recent plunge in gold prices showed, optimism about the US economy and its outlook was driving investment away from safe havens like the Australian currency and gold, and back into other investment vehicles such as the US equities market and greenback.

Already, the lack of increased inflation as economies printed more of their currency over the past few years meant investors felt they no longer needed to pile into the Australian dollar and use it as a hedge, like gold, against global inflation, ANZ currency strategist Andrew Salter said.

”Despite the truly considerable increase in global money supplies the world over, central banks have been largely successful in keeping inflation near target and consumer and business expectations in check,” Mr Salter said.

Whats next?

All eyes will be on Federal Reserve chairman Ben Bernanke as he speaks on Saturday in the US at a graduation ceremony, and testifies to Congress’ joint economic committee on the US economic outlook on Wednesday.

Any indication that suggests the Federal Reserve is open to winding back its bond-buying program – part of how it has been pumping money into the economy – could push the US dollar higher, and its flipside, the Australian dollar, down.

The falling Australian dollar could pare back expectations of a Reserve Bank rate cut in June.

Financial markets were pricing in a 19 per cent chance of a cut next month, and  the chance of at least one more cut by the end of this year.

Meanwhile, a 6 per cent decline in the exchange rate (the past 10 days has seen it decline by 5.6 per cent) could have the same impact as a 100 basis points interest rate cut, boosting economic growth by about 100 basis points over a couple of years, Barclays chief economist Kieran Davies said in a research note today.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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