Demise of ‘carry trade’ spells gloom for Australian dollar

Some of Australia’s top investors are still bearish on their country’s currency, which has been rooted near a post-crisis low on a combination of fears over wildfires and the impact of the big slowdown in China.

Last week the Aussie dollar hit a new 10-year low against the US dollar, shedding some 0.8 per cent in a single day after unemployment in January ticked slightly higher. While the data fell short of expectations by just a small margin, the reaction in the currency was significant, in line with recent trading patterns where the exchange rate responds to negative news while shrugging off brighter developments.

The currency, which is historically highly sensitive to commodity prices and economic developments in China, has lost more than 15 per cent of its value against the US dollar in the past two years, with one Aussie dollar worth just $0.65 compared with $0.78 at the start of January 2018. Since the start of 2020, losses have accelerated further.

“There remains little to like about the Australian dollar,” said Andrew Fisher, head of asset allocation at Brisbane-based pension fund Sunsuper, which had A$70bn (US$46bn) of assets under management last October.

The outbreak of coronavirus is likely to have a severe impact on Chinese economic growth prospects and in turn, those of Australia. Disappointing data have further bolstered views that the country’s central bank will be forced to cut rates this year from already record low levels. Domestic growth is anaemic, notching up just 0.4 per cent expansion in the third quarter of last year and likely to slow further.

Line chart of US$ per A$ showing Australian dollar loses more than a third of its value since 2011 peak

The result is that moves in the currency have become increasingly asymmetric, according to Stuart Simmons, a senior portfolio manager at QIC, a Brisbane-based pension fund with about A$80bn of AUM as of June last year.

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“When stocks rally, the performance of the Australian dollar is ambiguous, but when there’s a downturn, the currency’s sensitivity spikes and it follows risk assets lower,” he said. He noted that this behaviour was typical of the end of economic cycles.

Another historical correlation has recently broken down. When the dollar gains against the Japanese yen, the Australian dollar tends to move higher against its US peer as the pattern normally means a warming of investor sentiment, said Stephen Gallo, European head of currency strategy at BMO Capital Markets. Instead, the surge higher in the US currency on February 20 came while the Aussie dollar plunged.

“The standard relationship . . . has utterly collapsed,” said Mr Gallo.

One factor contributing to the breakdown of traditional patterns is the unusual backdrop in global interest rates. In the past, large local investors such as pension funds bought Australian dollars to hedge international investments, because they feared missing out on relatively high rates back home. But since May 2018 this relationship has been turned on its head: key rates in the US have been higher than in Australia, creating incentives for investors to leave money in the US currency rather than swapping them for the Aussie.

This trend has meant fewer buyers for the Aussie and led to the “death of the carry trade”, according to Mr Simmons.

“If anything [the situation] is becoming worse for the Australian dollar with the correlation to risk assets remaining strong to the downside while being weaker to the upside more recently, making foreign currency even more attractive,” said Sunsuper’s Mr Fisher.

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The Reserve Bank of Australia has done its best to stir economic activity, making three cuts to interest rates last year, to a record-low 0.75 per cent. The central bank stood firm at its policy meeting earlier this month, but analysts see more cuts down the road — possibly as soon as March 3, as the coronavirus continues to drag down growth in China, the country’s top trading partner by some distance. Analysts worry that growth in Asia’s biggest economy could halve in the first quarter from a rate of 6.1 per cent in 2019.

As a result of possible rate cuts from the RBA and the lack of investor interest in buying the currency, both Mr Simmons and Mr Fisher remain bearish on the Aussie dollar’s prospects.

Carl Astorri, head of asset allocation and research at Australian Super, the country’s largest pension fund with A$166bn of AUM last June, is “not as negative” on the currency as he had been a year ago, citing more stimulative monetary policy and better momentum in commodity prices.

“However, we do remain negative in part because of the impact of the coronavirus on the Australian economy, and also because the market could be underpricing the potential for further rate cuts,” he said.



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