April 1 (Bloomberg) -- Australia’s economy is vulnerable to a slowdown in China, where risks are “tilted to the downside,” meaning its dollar could slide even as domestic demand shows signs of improvement, Pacific Investment Management Co. said.
A decline in mining investment will be the biggest drag to growth in 2014, blunted to some extent by a rise in residential dwelling investment and improvements in business confidence, Adam Bowe and Robert Mead, Sydney-based money managers at Pimco, wrote in a commentary on the firm’s website. The fund manager favors positioning for declines in the Aussie as a way to hedge against a negative shock from China, which isn’t its central case, according to the report.
“While we still expect Chinese growth to slow gradually over the cyclical horizon, uncertainty has risen recently and risks to the outlook are tilted to the downside,” they wrote. Should China’s economy expand less than 6.5 percent, it will have negative implications for Australian growth with “additional policy accommodation likely needed from the Reserve Bank of Australia.”
China’s leadership is attempting to curb credit risks, reduce pollution and implement more market-based pricing. A Purchasing Managers’ Index for manufacturing fell to 48 in March, the lowest reading since July, from 48.5 in February, HSBC Holdings Plc and Markit Economics said today. The nation is Australia’s biggest trading partner.
Pimco expects China to grow in a range of 6.5 percent to 7.5 percent. The economy may struggle to maintain momentum as the government manages the fallout of excessive credit creation outside the banking industry, while also attempting to make structural reforms, Bowe and Mead wrote.
The local currency traded at 92.63 U.S. cents as of 4:15 p.m. in Sydney and earlier touched 93.04, the strongest level since Nov. 21. It gained 3.8 percent last month, the most among 16 major peers.
Low domestic growth means Australia’s economy will be vulnerable to external shocks, Bowe and Mead wrote.
Reports last month showed stronger-than-forecast employment, building and trade data in Australia. There are encouraging early signs that a transition from mining-led growth to domestic consumption is taking place and the economy may strengthen later this year, RBA Governor Glenn Stevens said in a March 26 speech in Hong Kong.
“We share the cautious optimism but stop well short of expecting higher policy rates this year,” Bowe and Mead said. “The RBA will want to see the unemployment rate start trending down before beginning a hiking cycle.”
The central bank will probably keep policy rates unchanged this year, and “risks to that view remain to the downside,” they said. The RBA held borrowing costs at a record-low 2.5 percent after a policy meeting today in line with all 33 economist forecasts in a Bloomberg survey.
Pimco predicts bond yields will probably rise gradually in Australia, “particularly in the longer end of the yield curve, which isn’t supported by anchored policy rates,” according to the report. The fund manager is running less duration risk relative to its benchmarks and adding to holdings of high-quality credit with three-year to five-year maturities, Bowe and Mead wrote.
Newport Beach, California-based Pimco, which manages the world’s largest bond fund, is a unit of the Munich-based insurer Allianz SE, oversees about $1.9 trillion in total.
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