Bearish Aussie avoided by pandering to China

THE Australian dollar has been trading around its six-week high this week, receiving a boost from encouraging data coming out of China – a country upon which its economy relies on heavily. At the same time, it has benefited from a strong commodity market. The Aussie dollar was trending around the $1.0400 area yesterday, but according to Stephen Gallo, head of market analysis for Schneider FX, any continuation of this strong run is dependent on a Chinese soft landing: “Ultimately, this means less chance of aggressive tightening,” says Gallo. “This is bullish for base metals, it’s bullish for risk appetite and therefore it is supportive of a higher Australian dollar.”

Though it may seem slightly odd to spend so much time focusing on the Chinese economy, but then trade the Australian dollar, it does make sense. As a closed currency, the Chinese renminbi does not react to the perceived health of the Chinese economy as it would in normal circumstances. But Australia does most of its trading with China, rather than the US. As a result, the Australian dollar acts as a good proxy for forex traders wishing to take a position on China. While this may make Aussies squeal during a Chinese downturn, they are currently enjoying the benefits of Chinese demand for Australian commodities. October’s HSBC purchasing managers index report released on Monday showed that Chinese manufacturing activity had hit a five-month high, contributing to the dollar-Australian dollar highs. “In China, there are many domestic issues that the central government needs to deal with, but these issues are not the same kind of structural issues facing the US and certain European countries at present,” says Christina Chung, senior portfolio manager for the Allianz RCM China fund. Chung says that China is not burdened with external debt, has large foreign exchange reserves, high domestic savings, a controlled currency and largely closed capital accounts. All of which suggest that there will be no forced currency devaluation by hedge funds or capital flight by domestic citizens which would typically drive a downward spiral at times of crisis.

Though the Aussie dollar is reliant on Chinese strength, it is of course also influenced by its domestic economy. Climbs against the dollar and euro have been kept in check by the anticipation of a possible interest rate cut by the Reserve Bank of Australia (RBA) after third quarter producer prices under-shot expectations, rising only 0.6 per cent.

Traders should look to continued long term strengthening of the Aussie dollar but should be careful not to be caught on the wrong side of an RBA rate change.