How The Stubborn Australian Dollar Is Confounding Strategists Around The World

Getty/Stu Forster

The Australian dollar’s rebound from its worst plunge since 1985 is proving so strong that strategists the world over are having a hard time keeping up with the gains.

While the median year-end estimate for the Aussie in Bloomberg surveys of more than 50 analysts has risen to 90 U.S. cents from 86 cents in February, that’s still below its level of 94.01 cents today. Goldman Sachs Group Inc. raised its forecast yesterday. The currency has strengthened 5.2 percent this year versus a basket of the greenback, euro, yen and six other developed-nation peers, following a drop of 13 percent in 2013, Bloomberg Correlated-Weighted Indexes show.

Australia’s dollar is benefiting from the unprecedented cash central banks have pumped into the global system since the financial crisis struck some six years ago. That has damped volatility and boosted demand for the nation’s bonds, which yield the most among top-rated sovereign debt.

“As volatility has continued to decline, that has made global investors more willing to hold the Aussie dollar and earn the yield,” Ray Attrill, the Sydney-based global co-head of currency strategy at National Australia Bank Ltd., said in a phone interview yesterday. “The Aussie hasn’t fallen as far or as fast as we thought, and the ongoing grind lower in volatility is the primary reason for that.”

NAB predicts Australia’s dollar will fall to 85 cents by year-end, which would be a loss of about 10 percent. The Melbourne-based lender raised its third-quarter estimate for the Aussie to 90 cents from 87 cents, on June 16.

Goldman Forecast

Australia’s dollar has gained every month since January, even as iron ore, the nation’s largest export, dropped this month to an almost two-year low of $89 a dry ton. The Reserve Bank of Australia has expressed concern the currency’s strength risks doing harm to exports and the economy.

Goldman Sachs forecasts the currency will be at 88 cents in six months, up from a previous prediction of 82.

“We still expect lower commodity prices, a deteriorating trade balance and a better trajectory for U.S. economic growth to weigh on the A$ over time, but acknowledge the resilient performance of the A$ into recent commodity price weakness,” analysts including Tim Toohey, the bank’s chief Australia economist in Melbourne, wrote yesterday in a research note.

Volatility Vacuum

The Aussie is about even with its 93.62 level on April 15, when RBA Governor Glenn Stevens and his board said in the minutes of that month’s policy meeting that achieving “balanced growth” would be more difficult “given the rise in the exchange rate over the past few months.”

The Aussie’s gain versus other currencies in the Bloomberg indexes is the biggest after the New Zealand dollar’s 6.6 percent jump. Both currencies are benefiting from central bank policies around the world that have made money easy to attain and depressed price swings in assets from stocks from bonds.

Implied three-month volatility in Australia’s dollar fell to as little as 6.16 percent on June 13, the least since early 1997 and down from as high as 10.67 percent in January. It was at 6.48 percent as of 1:01 p.m. in Tokyo.

A lack of price swings is encouraging investors to borrow in currencies where interest rates are low and use the proceeds to buy assets in economies where they are relatively high, such as in Australia, with little concern that sharp exchange-rate movements would wipe out any profits.

Carry Returns

Australia’s benchmark interest rate of 2.5 percent is the highest among 10 major developed nations after New Zealand’s 3.25 percent and compares with near zero in the U.S., Japan and the euro zone. Its 10-year bond yield of 3.59 percent exceeds those of lower-rated Spain and Italy, as well as Portugal, which is considered as below investment grade.

Buying the Aussie with funding in U.S. dollars handed investors 6.7 percent this year, the second-best return among Group of 10 currencies. Traders who bought with euros earned 7.6 percent, and yen-funded purchases made 3.2 percent.

“The Aussie at this moment is too high compared to the yield spread as well as commodity prices, suggesting it’s overshooting the carry argument, even before” potentially negative economic data, Anezka Christovova, a foreign-exchange strategist at Credit Suisse Group AG in London, said yesterday by phone. Her bank predicts a drop to 87 cents by year-end.

Bond Demand

Demand for debt means Australia’s dollar will probably survive an increase in volatility, according to Geoffrey Kendrick, head of Asian currency and interest-rate strategy at Morgan Stanley in Hong Kong. The company sees the Aussie reaching parity with the U.S. dollar by year-end.

“There’s structural inflow from Japan, and also from sovereign-wealth funds and central banks to buy Australian government bonds,” Kendrick said by phone on June 24. “You’d have to see a massive jump in volatility to discourage that structural flow.”

Hedge funds and other large speculators are optimistic, with bullish wagers exceeding bearish bets by 27,029 contracts as of June 17, about the highest net-long position in 13 months, according to the Commodity Futures Trading Commission in Washington. As recently as April, they were net short.

“It’s just hard to fight the carry trade — we’ve been saying it’s the calm before the storm now for a few months, and it’s still calm,” Geoffrey Yu, a senior currency strategist at UBS AG in London, said yesterday by phone. “At some point volatilities will have to go up. We need a re-pricing of risk, and we’ll see Aussie-dollar correcting lower.”

While HSBC Holdings Plc sees the Aussie falling to 86 cents by year-end as the U.S. currency strengthens, investors seeking high yields are keeping it resilient for now, said Paul Mackel, the Hong Kong-based head of Asian currency research.

“We cannot ignore the fact that the Australian dollar is still the second-highest yielding currency among the G-10,” Mackel said yesterday by phone. “The carry trade can be a very alluring animal and investors are very reluctant to go against that until they actually start to see indications of volatility picking up.”

©2014 Bloomberg News

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