15/01/2013 - 12:20

Analysis: Pressure building in the Australian dollar

15/01/2013 - 12:20

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Apart from being the best looking currency in a world full of ugly competitors there are not many reasons for the Australian dollar to continue trading above $US1.05, leaving open the question as to whether there will be a slow slide, or a sudden fall.

Last week’s news that the country’s trade deficit in November hit a five year high of $2.6 billion was one of several indications that the economy is under pressure as the benefits of the resources boom continue to fade.

This week’s news, scheduled for release on Thursday, should be a rise in the level of unemployment, confirming the economic deterioration, to possibly be followed by a further cut in official interest rates.

From any angle, the outlook for the overall Australian economy is not encouraging with the only ray of hope being early-stage indications that the rest of the world is recovering and with that will come increased demand for commodities.

But, waiting for the economic cycle to turn full circle can be a time-consuming process as it runs a natural course; starting with a return of investors to higher-risk assets such as mining shares, with the capital allocated eventually flowing through into the wider economy.

Recent overseas evidence indicates that investors in Europe and the U.S. are starting to move out of the safety zone of government bonds, gold and relatively strong and high-yielding currencies such as the Australian dollar.

The hunt today is for more conventional assets and conventional currencies. The euro, for example, this week hit an 11-month high against the U.S. dollar thanks to European investors regaining confidence in their recession-dogged region.

Last week, as Australia’s economy took a turn for the worse, more money was invested in European and U.S. equity funds than at any time in the past five years, another sign of change on the way.

Dubbed the “great capital rotation” it should not be long before international investors ask themselves a question about ongoing exposure to Australia and its currency, both of which performed well in the years after the 2008 financial crisis, but with both looking less attractive compared with alternatives.

Australian exporters can hardly wait for a currency correction as shown in these two examples:

  • Casella Wines, maker of the forgettable Yellow Tail family of wines which had been selling well in the U.S. suffered its first loss in more than 20 years because of intense competition in the American market and the effects of the high Australian dollar which boosted the price of what should be a cheap drink.
  • Germany, hiding behind the euro which has been depressed by the crisis in Greece, Italy, Spain and the rest of southern Europe, saw its exports hit a record high of more than $US1.33 trillion in 2012, an increase of 4.3%.

Currency is not the only factor at work in those two cases. Quality has a lot to do with it, and while it might seem odd to compare Yellow Tail wine with car brands such as Mercedes, Audi and BMW and most readers get the point.

The problems at Casella, Australia’s third biggest wine-maker, are symptomatic of a country which has had an easy ride for the past decade, exporting raw materials to China and enjoying the benefits of a currency which was valued at US50c (and less) just 10 years ago.

It is highly unlikely that the Australian dollar will fall back to its lows of a decade earlier, but there is also no doubt that pressures are building in the economy, and those pressures will eventually be felt in the value of the currency.

Just as Australia has benefited from its curious status of last-man standing in a world of falling currencies, so too might it soon be seen as a weaker currency in a world where stability is returning, despite the massive debt loads being carried by governments in Europe and the U.S.

Debt is actually another interesting point in the currency situation because while it is easy for Australian observers to point to the multi-trillion dollar debt burden of the U.S. and Europe those regions have started to attack the issue.

Australia, however, is increasing its debts, and will probably continue to do so in an election year when both government and opposition will try to win votes with promise of spending money that they do not have.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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