Aussie outlook spinning around

THE Reserve Bank of Australia (RBA) yesterday called the end of the country’s commodities boom, citing the effects of the Chinese slowdown on the mining sector.

At the same time, it announced that the official cash rate will be cut by a quarter of a point – down to 3.25 per cent. This latest drop takes the cuts over the last five months to a percentage point, with governor Glenn Stevens talking of a revised growth outlook, dragged down by China and an Asia-wide slowdown; as well as the usual story of collapsing European demand and weakening US fundamentals.

Though Stevens iterated that capital markets remain open to corporations and well-rated banks, and Australian banks have had no difficulty accessing funding, including on an unsecured basis. But like other highly rated sovereigns, the low risk appetite environment has seen long-term interest rates at exceptionally low levels.

The Australian outlook for miners comes in stark contrast to the metals that they’re drilling out of the ground. Last month’s announcement by the US Federal Reserve that it would be unleashing an open-ended round of its controversial quantitative easing programme gave the yellow metal a boost and sent it back into the bullish trend that had marked most of 2011. On Monday, it touched its highest level of the year at $1,791.20, and it has traded in the $1,700-$1,800 range since the Fed’s announcement last month. The programme is set to run until there is a strong improvement in the US labour markets, and so eyes will be on the US non-farm payroll numbers when they are released on Friday. But whether or not these figures disappoint, and whether or not the effects of QE3 are already priced in, a good week for spot gold prices and on exchange futures transactions does not necessarily filter down to the gold mine in Western Australia.

Though gold has hit the headlines, the Australian prime minister has said that an overall fall in commodity prices over previous months had led to some mining and exploration companies changing their investment intentions. “The peak in resource investment is likely to occur next year, and may be at a lower level than expected,” said Stevens. Australia’s terms of trade – its price of exportable goods compared with its price of importable goods – has dropped by around 10 per cent as a result of the commodities slowdown. This figure is expected to fall further.

The rate cut reflects the difficult position that Australia finds itself in. Its currency, its commodity and mining sectors, and ultimately its economy as a whole, have been heavily dependent on China. Due to the capital controls in place in the People’s Republic, currency traders unable to take outright positions on the renminbi have instead used the Australian dollar as a proxy trade on Chinese fundamentals. But while this relationship has been kind to Australia in the good times, it has left the country equally exposed to its downturns.

However, despite this revised outlook, Australia is still in a strong position in comparison with other high-ranked sovereigns. It has low benchmark rates and inflation, low unemployment and good growth. Courtesy of a sluggish US economy, dollar strength is limited. “The Australia-US two year bond spread has recently narrowed from 270 basis points in mid-September to 216 basis points today without a significantly dampening effect on the Aussie dollar,” says Richard Grace, chief currency strategist at the Commonwealth Bank of Australia (see chart, above). “We would use this dip in the Australian dollar-dollar as a buying opportunity because the big picture has not changed significantly,” says Grace. “Global real money demand for the Aussie dollar remains strong, attracted by Australia’s AAA sovereign rating, close to trend domestic growth and still high real interest rates.”

Australia has suffered a setback due to the size of its commodities sector. But in the current economic climate, it is not in the worst position to ride out the economic storms facing the world.