Is the Australian dollar priced for a big fall?
The Australian dollar has for many years been seen as a proxy bet on strong commodity prices and demand ,which in turn are viewed as a barometer of the health of China's economy. But is Australia's fantastic bull run soon to end? Views are mixed.
The Reserve Bank of Australia held back from more rate cuts recently and in terms of economic fundamentals, Australia's look far better than those of Europe, US and Japan. But the country's Achilles' heel partly lies in its current account deficit, which according to its Treasury department could hit 4.75% of GDP in 2012-13 and 6% the year after that – an uncomfortably high figure in a world nervous about economic imbalances and anything that looks potentially unsustainable as the Eurozone knows only too well.
The Australian Treasury says much of the deficit is down to imports of capital equipment linked to the development of new mines, so in that context it is a long-term positive as it is investment that should lead to more output and exports, providing there are markets for it.
And that dovetails with the fact that the longer-term strength of the Australian dollar might be determined largely by China, which is among the world's top buyers of commodities. There's an ongoing debate over whether China will have a hard or soft landing. Trader Jim Chanos is in the former camp arguing that there's been an over-sized real-estate bubble and there's a lack of internal demand to keep the financial sector healthy. That's potentially bad news for industrial commodities, which Australia exports, as construction activity could slow.
On the other hand, Chinese investment bank, China International Capital Corporation, said at a presentation in London a few months ago that it believes China will experience an economic boom from next year due to a raft of financial and economic reforms. However, that forecast comes with a sobering assessment on Chinese metals demand. They reckon the intensity of usage of metals will decrease in China as its economy develops more towards a consumer driven model and therefore less reliant on exports and building infrastructure. With new supplies coming online CICC are less confident over the prospects of metals prices. They are however a little more bullish on Chinese energy usage.
But UK financial services group, Standard Life, reckons the Australian dollar “looks priced well above perfection” when the individual components are analysed. It notes the China slowdown as being a factor and that strong commodity demand has necessitated high interest rates in Australia to stop the economy boiling over. But with inflationary expectations easing and with slowing local employment conditions the scene could be set for more cuts in interest rates potentially removing one of the big attractions of the Australian dollar, namely its yield. And on top of that there's the fact that it is seen as a de-facto risk asset. Indeed, with so many foreigners holding Australian dollars there is a risk that it could be sold off aggressively and fall rapidly if the world's economic outlook were to deteriorate significantly.