- Currency dropped 4.5% over the past month, worst G10 performer
- Inflation-adjusted yields higher than U.S., Germany, Canada
For a clue on why global currency strategists see an end to the Australian dollar’s tumble, look at the yields the nation’s bonds offer after accounting for inflation.
So-called real yields on Australia’s 10-year bonds are higher than in the U.S. and compare with negative levels for debt sold by Canada, France, Germany, Japan, Sweden and the U.K. That may limit the central bank’s ability to weaken the Aussie with lower interest rates. Citigroup Inc., the world’s largest foreign-exchange trader, says the currency remains attractive in a “world of zero interest rates.”
Real yields are growing in importance for currency markets around the world after nominal yields collapsed thanks to the unconventional policy initiatives taken by central banks in the euro area, Japan and the U.S. to fend off deflation. While price growth has remained listless, nominal yields in a number of developed countries are now at levels where investors are no longer compensated for inflation. That makes Australia stand out even after yields on many of its government bonds fell to records this month.
“There’s a real interest rate argument to justify the resilience of the Aussie dollar,” said Ray Attrill, co-head of currency strategy at National Australia Bank Ltd. in Sydney. “If you think real interest rates ultimately matter more than nominal rates -- which does seem to be the case -- then this is of some relevance to the Australian dollar given that much of the rest of the world currently has negative real rates.”
With the Australian dollar down 4.5 percent over the past month, the most among major developed peers, analysts see limited room for further losses. It will end the year at 73 U.S. cents, from 73.35 as of 7 a.m. in London on Thursday, based on the median of 19 estimates compiled by Bloomberg since the Reserve Bank of Australia reduced its cash rate to an unprecedented 1.75 percent last week. At the start of 2016, strategists predicted a rate of 69 cents by year-end.
While futures are pricing in a follow-up cut by the RBA in November, NAB sees domestic policy becoming less important for the Aussie. The benchmark cash rate was recently at the highest in more than a year relative to living costs, with price growth at the slowest ever.
Since mid-2014, Australia’s core inflation has dropped from 2.75 percent on average to 1.55 percent in the first quarter. Headline inflation sagged to 1.3 percent from 3 percent. Over that time the RBA lowered its cash rate by 75 basis points.
While RBA Governor Glenn Stevens and his board appear to be back in easing mode, they are hardly alone. Policy makers in New Zealand, Japan, the euro-area, Norway and Sweden are among peers that have added monetary accommodation and markets estimate a better than 50 percent chance the Federal Reserve won’t raise rates in the U.S. this year.
Adding to the Aussie’s advantage are RBA forecasts for growth of 2.5 percent to 3.5 percent this year and next, holding unemployment around the current 5.7 percent. Consumer confidence revived to its strongest since early 2014 after the rate cut, a report Wednesday showed.
The economy’s underlying resilience helped trip up investors earlier this year when the currency was trading at its weakest in seven years. From a January low of 68.27 cents, the Aussie surged to a 10-month high of 78.35 in April as hedge funds and other large speculators boosted bullish bets.
“When we were sub-70 in January, you couldn’t give the Aussie dollar away, and it was a pretty bitter experience for many to watch the Aussie recover 10 cents from there,” said NAB’s Attrill. “That’s impacted views on the Aussie.”
The past few weeks have been hard on the bulls, with the currency sliding after disappointing price data forced RBA action. Officials said days later that inflation will probably miss the bottom of their target band even with another cut priced into markets.
None of that changes the outlook for the Aussie as external factors tend to dominate domestic developments, said Todd Elmer, a Singapore-based foreign-exchange strategist at Citigroup. The currency’s standing as a higher-yielder as well as Australia’s links to emerging-market growth are likely to be more important in an environment where the Fed’s reluctance to signal higher rates weakens the U.S. dollar, he said.
“There is a risk we break the previous highs on a rebound in asset prices, U.S. dollar selling, EM buying and improved sentiment,” Elmer said. “There should be significant scope for investors to rebuild these positions and the Aussie should benefit as a knock-on effect. As investors return to the region it is likely to see proxy buying.”