AUSSIE DOLLAR CAUGHT IN A TUG-OF-WAR

FINANCIAL FEATURES WRITER

GIVEN its usual position as a proxy for risk and its draw as a high-yielding currency in a sea of near-zero yields, the Aussie dollar ought to be surging against its pairs. A tug-of-war is ongoing between carry trade demand for yield and European economic weakness on the one side and a Chinese slowdown weighing on commodity demand on the other. The latter has been winning.

Australian economic dependency on China was highlighted yesterday when BHP Billiton’s president, Mike Ashley, raised concerns that Chinese iron ore demand may be on the wane. BHP Billiton is Australia’s largest company by market cap, so concerns raised about Chinese demand for Australia’s crucial iron ore exports sent the Aussie dollar tumbling (see chart, below). This news should not have been entirely unexpected following Chinese revisions of growth expectations from 8 per cent to 7.5 per cent. However, markets seized this confirmation of Chinese softening to sell off the exposed Aussie dollar – prompting a decline to $1.0583 from $1.0620 against the US dollar and the worst Aussie dollar-dollar performance since 3 January. The Australian dollar also fell against the yen to ¥88.18 from Monday’s close of ¥88.40 – the first Aussie dollar decline in four days against the Japanese currency.

Minutes from the Reserve Bank of Australia’s (RBA) 6 March meeting were bullish overall, but pointed to Eurozone turmoil weighing on Australian export demand and an over-valued Aussie dollar, meaning that caution was required from the central bank. Although Australia has benefited from surging commodities prices and mining investment, this has been at the expense of its retail and manufacturing sectors, as the strong currency has dented trade. The minutes indicated that the central bank has lowered its forecasts for a deteriorating Australian economy and the requirement of a loosening of monetary policy. They stated: “Members noted that while this downside risk could still materialise, this seemed somewhat less likely than a few months ago.”

However, the central bank, which cut its key rate in November and December last year, said that it had “ample scope” to cut interest rates further if needed – somewhat against the expectation that they would be raised rather than cut. They are currently at 4.25 per cent. With first-quarter inflation data to be released on 27 April, markets will be eyeing the May RBA meeting for a move in the base rate.

The BHP Billiton news does nothing to change Aussie fundamentals as a draw for those seeking high yielding currencies. While the news of slowing Chinese demand has taken the wind out of the sails of the Aussie, when markets switch into risk-on mode, demand for the Aussie dollar will remain, outweighing the considerations of Chinese and European demand for the Aussie dollar-dollar pair.