Australia looks fantastic. Time to get out then

IN AUSTRALIA, it is summer in more ways than one. The Fed might be gearing up the printing presses again for winter, but down under the economy is actually booming. In a move unseen anywhere else in the developed world, the Reserve Bank of Australia (RBA) decided on Monday night to increase interest rates by 25 basis points, up to 4.75 per cent. As a result, the Australian dollar is now worth more than the greenback. That’s a heady altitude for a small currency to live at, however. Can the Aussie keep climbing, or must it now begin a graceful descent?

Certainly things look good at the moment. Buoyant commodity prices have pushed up Australian terms of trade to a level last seen in the 1950s. Thanks mostly to Chinese demand for raw materials, Australia actually managed to avoid slipping into recession. Now it is looking positively bouncy. Glenn Stevens, the governor of the RBA, said in a statement that he believes that there is only a “modest amount of spare capacity” left in the Australian economy, citing low unemployment levels as evidence. That hints that further increases in the interest rate may still be to come.

Unsurprisingly then, many traders are looking very bullish. Michael Derks, chief strategist at FxPro, says that it was mostly “sticker shock” holding the Aussie below parity. Given time, that level could well become ordinary, especially if Chinese and Indian demand for commodities like iron ore and coal continues to grow. With encouraging data out yesterday for industrial production in China and the US, that seems entirely plausible.

Stephen Gallo, of Schneider Foreign Exchange, thinks that is a mistake, however. In his analysis, global imbalances, and in particular an overly weak Chinese renminbi, are driving up commodity prices in a way that isn’t really sustainable. According to Gallo, growth in Chinese manufacturing will eventually have to decelerate. That will in turn lessen demand for raw materials and so push the Australian dollar back down again. Given that, forex traders might be wise to take a short position, at least in the medium term.

Much depends on what the Federal Reserve does later today. If it chooses to expand the money supply particularly aggressively, then probably the Aussie will climb further against the dollar, as traders seek respite in commodities and higher yield currencies. However, most of the impact of quantitative easing is likely to be already priced into the Aussie.

Because of that, it might be a good time for forex traders already long on the Aussie to take profits and get out. For six months or so, traders have flocked to Australia like birds flying south for winter. Probably, they will stay for a while, but no one is really sure. Given the chance of something going wrong, especially to commodity prices, why risk hanging on?