Morgan Stanley analysts sound the alarm about the Aussie dollar, favourite of at-home Forex punters:
The AUD is now the most overvalued of all the currencies we
monitor, at 37%. This is not a reason in itself to revert but
implies that any signs of stress could see a sharp adjustment.
The fact that there are a number of issues which have the
potential to generate downward pressure on the currency
ensures we have warning signs of a reversal.
Household Leverage Remains High
Australians have embraced the Anglo-Saxon debt philosophy
wholeheartedly. However, unlike the US or UK, they have not
seen a correction in debt levels or house prices. Australian
household debt to income remains at extreme levels even
compared to their Anglo-Saxon counterparts (Exhibit 3).
Australian household debt levels have been supported
through the downturn by: the modest adjustment in the labour
market, the rapid flow-through of lower interest rates to
mortgage payments, and the stability of the domestic banking
sector, which has maintained its intermediation role.
This leaves households exposed to the RBA’s rate hiking
cycle at relatively high debt levels and a higher level of
unemployment. It is true that the labour market should
improve and is a lynchpin for household resilience. Thus it is
only a risk that there is enough pressure on households to de-
leverage. Given that there was not a large increase in
unemployment during the downturn, as firms chose to cut
hours worked instead, our economists are not expecting a big
improvement in the labour market through 2010.
Next year is a concern as incomes should begin to slow. The
reversal in tax and interest rate cuts should reduce income
and raise the debt/income ratio. This also bears watching as a
stress on households with such high leverage.
Again, similar to its Anglo-Saxon counterparts, the Australian
housing market has seen an acceleration in house prices.
However, unlike in the US or UK, there has yet to be a
correction. The RBA have noted the run-up in housing prices
and may wish to address this through their hiking cycle. The
general market belief is that this bubble can be gently pricked
and deflated. The risk is that it faces a more disorderly
unwinding at some future point, which is also a threat to AUD.
As our economics team points out, the run up in house prices
is reflective of the increase in debt levels (Exhibit 4) and is not
the product of more fundamental factors such as population
changes or rental income equivalents. Additionally, there is
likely to have been a change in demand, as years of rising
prices have changed household formation dynamics. The
RBA have noted that members per household have risen in
recent years, bucking a long-term trend. This would suggest
that supply-demand imbalances are not as large as demand
estimates based on historical averages would suggest.
The end of a bubble is always difficult to predict and
identifying the trigger for such an unwind is similarly fraught
with difficulty. Given that markets are extremely sensitive to
the potential for asset price bubbles bursting and with the
effects of such events still in mind, the Australian housing
data are key to AUD maintaining its lofty levels.
More recent housing data have been relatively robust, but this
may not last. The run-up in building approvals and housing
finance data can be partially attributed to the government’s
increased first-home-owner grants. This policy, implemented
in the financial crisis, provided an additional $14k for newly
built houses and $7k for existing houses – on top of the
original $7k grant. This expired at the end of October. The