Tags: Global | Pressures | Australian | Dollar

Global Pressures May Catch up With Australian Dollar

Wednesday, 16 February 2011 08:17 AM

With the Group of 20 meeting coming up at the end of the week in Paris, Brazilian Finance Minister Guido Mantega made interesting remarks on the occasion of Treasury Secretary Tim Geithner visit to Brazil when he was asked if the U.S. and Brazil have drawn up a common position on currency policy ahead of the G-20 meeting.

“The initiatives of the countries are individual, we have no common action planned,” Mantega said. Brazil is as concerned with the weakening of the dollar as it is with the Chinese currency (CNY).

If you ask me, notwithstanding the good intentions of the G-20, this already demonstrates that unavoidable nasty “currency wars” are building.

I think investors could do well putting the Australian dollar on their watch list and act when they think it is appropriate.

Yes, the Australian dollar (AUD) has been one of my favorite currencies, but nothing is forever. Now, and this isn’t good news for “down under,” and here I mean Australia as well as New Zealand, Moody's Investors Service has just placed on review for possible downgrade the Aa1 long-term, senior unsecured debt ratings of the Australia and New Zealand Banking Corp., the Commonwealth Bank of Australia, National Australia Bank and Westpac Banking Corp.

Patrick Winsbury, a senior vice president based in Moody's Sydney office, says: “The review will focus on the Australian banking system's structural sensitivity to conditions in the wholesale funding market. The global financial crisis has underlined the speed with which shifts in investor confidence can impact bank funding, warranting a review of the four major banks, for which market funds comprise on average 43 percent of total liabilities.”

Also, Moody's Investors Service just placed, in a “logical” move, on review for possible downgrade the Aa2 long-term senior unsecured debt and deposit ratings of New Zealand's four major banks: ANZ National Bank Limited, ASB Bank Limited, Bank of New Zealand, and Westpac New Zealand Limited.

Marina Ip, an assistant vice president based in Moody's Sydney office, says: “The review of the New Zealand major banks' ratings is a direct consequence of a similar review of their Australian parent banks’ ratings. The ratings of the New Zealand major banks incorporate the potential for parental support, so a change in the ratings of their parents' could potentially affect their ratings also. At the same time, the review will focus on the New Zealand major banks' structural sensitivity to wholesale funding market conditions.”

On a broader scale I’d also like to say that the actual apparent sluggishness of the Australian dollar lends support to my views, in my opinion at least, that the relentless rise in commodity prices is exacting a growing toll on global economic stability.

Indeed, when we look at the close correlation between the AUD/USD pair and the Reuters CRB commodity index, which has been at just over 70 percent since 2002, we note the two series have moved in tandem post-crisis and, interestingly, also paused together in mid-2009, before restarting their simultaneous uptrend in June of 2010.

However, and while we aren’t talking on a day to day relationship-basis, we cannot ignore the AUD losses that are about 2.30 percent against the U.S. dollar since a Feb. 4 high of 1.02, while equally over the same time period the CRB index has moved down over that same period from about 345 to 336.28 at yesterday’s close in N.Y.

I have no doubt that the Australian dollar’s role as a China “proxy” is the main reason for reassessing the Australian dollar’s traction at current levels against the U.S. dollar.

So, for now and despite what they call a more “modest” rise of 4.9 percent in China’s January CPI (Consumer Price Index) than expected but nevertheless 0.3 percentage points higher than December CPI and food prices rising 10.3 percent on a y/y basis, I think it’s not an overstatement to say it has become clear the Chinese authorities may fear that that they are in danger of losing the battle with inflation.

Despite seven hikes in banks’ reserve requirements since the start of 2010, three rate hikes over the past four months and a variety of differing measures designed to quell food price inflation, pressures continue building in China where, unfortunately, “nature” isn’t certainly helping either as they are facing the worst droughts in 60 years.

Moreover, with bank lending having risen by 1.0 trillion yuan (CNY) in January alone, which, no doubt about that, bodes ill for the PBOC’s new purported target for the year of around 7.2 trillion yuan (CNY).

We could say that the PBOC is back at square one and the prospect of further, more draconian measures is only growing. Keep in mind that it’s only since yesterday we could read in a report by the State Information Centre under the National Development and Reform Commission that said the PBOC may increase the bank deposit reserve ratio to 23 percent from the current 19.5 percent.

The report concluded in clear terms: “The tool of imposing higher reserve requirements (RRR) will be the first choice for the central bank.”

No doubt whatsoever that China is becoming is a growing “risk factor” while they try to deflate their property boom that in turn highlights the Australian dollar’s vulnerability at current levels.

Investors shouldn’t overlook the fact that the “triangulation” between Australian trade, commodity prices and Chinese demand has been the dominant influence on the Australian dollar’s performance over the past few years, the Reserve Bank of Australia’s (RBA) aggressive policy so-called “normalization” policy in 2009/2010 also made the currency an obvious target for yield enhancement with near zero interest rates prevailing in the most important economies in the world.

And here we should take care, in this area too, the Australian dollar has lost some of its attractiveness and it is “open for questioning” that also for this reason that the CRB’s close relationship with AUD/USD broke down in Q4 of 2010.

A growing succession of poor Australian economic data releases since mid-year of 2010 has planted seeds of suspicion that the Reserve Bank of Australia’s rate-hike cycle was drawing to a close. That was confirmed and on Dec. 16, 2010, when the RBA stated that “the overall stance of monetary policy was back in the normal range” paraphrasing hereby Deputy RBA Governor Ric Battellinio.

Notwithstanding the Australian economy continues to perform good albeit somewhat slowing (see the most recent OECD chart hereafter), much of what we have heard from the RBA has pointed to they have put aside, for the time being at least, further rate hikes for the foreseeable future.

In fact, Governor Glenn Stevens clarified this just last week: “… it is probably reasonable that there will be no hike in interest rates for some time…”

All of this has also had the effect of capping the relentless rise in Australian bond yields from their lows early last year hereby contributing to a steady descent in the yield gap with the two year U.S. note that has closely tracked AUD/USD since the start of 2009.

Most damaging is the price action itself that seems to have started a rather bearish technical picture for AUD/USD.

Although the pair is clearly deriving some support from its post-November uptrend which at the moment of this writing is at 0.9960, a breach of this level would only serve to clarify a daunting head and shoulders reversal pattern that goes back to October 2010, which points to a theoretical downside target of 0.9350.

Of course, additionally we have today’s Moody’s downgrade story that could be seen an appropriate catalyst for such a downward move.

Anyway, it seems clear that the next few sessions could well prove to be particularly significant as far as the Australian dollar’s post-crisis performance is concerned.

Yes, the Australian dollar, one of my favorite currencies, is now on my negative watch list.

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With the Group of 20 meeting coming up at the end of the week in Paris, Brazilian Finance Minister Guido Mantega made interesting remarks on the occasion of Treasury Secretary Tim Geithner visit to Brazil when he was asked if the U.S. and Brazil have drawn up a common...
Wednesday, 16 February 2011 08:17 AM
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