Aussie’s Resilience Unwelcome Gift for Abbott: Australia Credit

Australia's Prime Minister-Elect Tony Abbott
Tony Abbott, Australia's prime minister-elect, delivers his victory speech at the Liberal-National coalition's election function in Sydney on Sept. 7, 2013. Photographer: Brendon Thorne/Bloomberg

The Australian dollar’s strongest weekly advance since December 2011 is a reminder to Prime Minister-Elect Tony Abbott that his plans to revive a slowing economy will be hostage to currency markets.

The Aussie rose 2.3 percent last week on a trade-weighted basis as signs of a revival in Chinese economic growth led investors to buy Australia’s assets. The coalition led in 86 of the 150 seats in parliament’s lower house, where government is formed, compared with Labor’s 57, the Australian Electoral Commission said on its website. That would give it a majority comparable to that won by John Howard’s coalition in 2004.

The Reserve Bank would prefer to rely on currency declines to help offset the end of a mining investment boom as a household savings rate near a more than two-decade high blunts the impact of record-low borrowing costs, according to National Australia Bank Ltd. The median forecast is for the Aussie to trade at 88 U.S. cents in a year, slowing this year’s 12 percent slide that has the potential to boost corporate earnings.

“The current state of the economy is screaming for some further easing in monetary conditions, against a backdrop where fiscal policy is basically hamstrung from doing anything,” said Ray Attrill, the global co-head of currency strategy at NAB in Sydney. “Any rebalancing that might be under way from the exchange-rate fall that we’ve had to date is going to be undone, or blunted, if the Aussie goes back to 95 cents.”

Higher Yields

Two-year government yields rose 19 basis points this month to 2.63 percent, the steepest advance among developed nations, after RBA Governor Glenn Stevens failed to mention scope to cut interest rates following a Sept. 3 board meeting.

Benchmark 10-year yields slid five basis points today to 4.09 percent, paring their advance since Aug. 30 to 20 basis points. The premium over similar-dated Treasuries was 115 basis points.

The Aussie was little changed at 91.91 U.S. cents as of 12:37 p.m. in Sydney after earlier touching a three-week high of 92.21 cents. It rose 3.2 percent to 91.85 cents last week.

The S&P/ASX 200 Index of shares advanced 0.4 percent to 5,165.70, after touching a 15-week high on Sept. 3.

Abbott’s coalition has vowed to achieve a budget surplus equal to 1 percent of gross domestic product within a decade. Its challenge will be to implement promised tax cuts, including lowering the company rate by 1.5 percentage points to 28.5 percent, and fund pledges such as a A$5.5 billion ($5.1 billion) per year maternity-leave program at a time when government revenue forecasts are falling.

Weaker Aussie

A 10 percent drop in the Aussie boosts gross domestic product by between 0.5 percentage point and 1 percentage point over about two years, the RBA estimated in its August monetary policy statement. Governor Stevens reiterated last week that further declines would “help to foster a rebalancing of growth in the economy.”

Australia’s dollar, the world’s fifth most-traded currency, touched a three-year low of 88.48 U.S. cents on Aug. 5. The RBA has welcomed the currency’s plunge at the end of a world-beating four-year rally that saw it hold above $1 for a record 10-month stretch.

China Proxy

The currency is used as a proxy for Asia because of Australia’s ties to the region, which buys more than 70 percent of its merchandise exports, according to Commonwealth Bank of Australia. The Aussie accounts for 8.6 percent of global currency turnover, nearly equal to the combined 8.8 percent share for the tenders of China, Hong Kong, Singapore, Korea, India, Taiwan, Malaysia, Thailand, Indonesia and the Philippines, according to data from the Bank for International Settlements’ triennial survey published Sept. 5.

China’s exports increased more than estimated in August, data reported yesterday showed, adding to evidence the world’s second-largest economy is rebounding after a two-quarter slowdown. Overseas shipments rose 7.2 percent from a year earlier, the General Administration of Customs said in Beijing yesterday. That compares with the 5.5 percent median estimate of 46 economists surveyed by Bloomberg News and July’s 5.1 percent gain.

Chinese manufacturing strengthened in August, with the official Purchasing Managers’ Index jumping to a 16-month high, a Sept. 1 report showed.

Prospects for a stabilization in Chinese growth, at a time when U.S. unemployment is falling, are prompting investors to lower bets on further rate cuts by the Reserve Bank.

RBA Outlook

Swaps traders priced in a 38 percent chance that the RBA will cut its 2.5 percent record-low benchmark again this year, from 74 percent on Aug. 6, data compiled by Bloomberg show.

“The Aussie has stabilized and that adds to the difficulty facing the RBA as it weighs up policy over the next few months,” said Sean Callow, a Sydney-based senior currency strategist at Westpac Banking Corp. “The new government is facing a currency that’s still quite strong and therefore a headwind to export growth and also it reduces corporate tax revenues.”

Sluggish Economy

A stronger currency would imperil an economy already forecast by the RBA to grow at the slowest pace since 2009. Economists project a 15 percent probability that Australia will enter a recession, defined as two consecutive quarters of negative growth, within the next 12 months, a Bloomberg survey last month showed.

Gauges for manufacturing and construction have indicated declining activity for more than two years, hampering the RBA’s efforts to shift growth momentum from resources to other parts of the economy.

As mining activity slows, the nation’s unemployment rate is predicted to climb from a more than three-year high of 5.7 percent to 6.25 percent by the middle of 2014, according to estimates from the Treasury department last month. The former government estimated the budget deficit will expand to A$30.1 billion in the 12 months ending June 30, from a previous forecast of A$18 billion.

Equities Outperforming

Equities are outperforming bonds, which have sold off amid a global rout on prospects Federal Reserve Chairman Ben S. Bernanke will announce this month plans to curb the U.S. central bank’s $85 billion a month of asset purchases.

Australian sovereign bonds delivered a 1.3 percent loss to investors this quarter, heading for their steepest decline since 2009, Bank of America Merrill Lynch indexes show.

The Aussie’s decrease this year has been bolstering earnings forecasts. UBS AG estimates earnings growth of as much as 7 percent for the 2014 financial year, with at least two percentage points stemming from currency declines. The benchmark S&P/ASX 200 equity index has climbed 7.1 percent this quarter, led by a 14 percent advance for materials companies and a 12 percent gain for the energy index.

“Some very large key constituents, particularly in the materials space, have been lagging in the past year or so and they’re finally catching up,” said Peter Esho, chief market analyst at Invast Securities Co. “The currency fall has really helped that.”