Aussie Debacle Flags China Hard Landing as Iron Market Melts
From the end of 2008 through July, no major currency appreciated as much as Australia’s dollar, thanks to booming shipments of iron ore and other commodities to China. Since then, it’s the worst performer as the engine of world growth slows.
The so-called Aussie depreciated 1.5 percent in the past month, the biggest decline among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. Traders are betting Australia’s central bank will cut interest rates to boost growth, dragging down the currency even though the Standard & Poor’s GSCI Index of commodities has risen about 18 percent from its low this year in June.
This reversal shows the dangers for an economy tied too closely to another. China, which buys 28 percent of Australia’s exports, said industrial output grew at the slowest pace in three years last month as Europe’s debt crisis cut sales of Chinese goods. Polls show Prime Minister Julia Gillard’s governing Labor Party is under pressure before elections due next year.
“The Australian dollar is very expensive from whichever metrics you look at,” Dagmar Dvorak, a director of fixed-income and currencies in London at Baring Asset Management, which oversees $50 billion, said in an interview on Sept. 20. “When a currency overvaluation is that extreme, you have to question what could be a trigger that stops it. For the Aussie, it’s the economic slowdown in China and falling commodity prices. The currency looks vulnerable.”
Baring has joined Credit Suisse Asset Management and Quantum Global Investment Management as onetime bulls turned bearish. The Australian dollar was 39 percent overvalued against its U.S. counterpart on Sept. 20 as measured by the Organization for Economic Cooperation and Development. That’s more than other currencies that tend to rise and fall with commodity prices, such as those of New Zealand and Canada.
The Aussie appreciated to its highest level against the U.S. dollar in about six months on Sept. 14, after the Federal Reserve announced a third round of bond buying designed to boost growth and reduce unemployment. The gain was short-lived, and the currency has since weakened against 13 of its 16 major counterparts.
Australia’s currency fell 0.9 percent last week as a report on Sept. 20 showed China’s manufacturing may contract for an 11th-straight month and an International Monetary Fund official said the same day it would cut its forecasts for global economic expansion. The Aussie was at $1.0408 as of 12:33 p.m. in New York today, 0.5 percent lower than the close on Sept. 21.
“We are worried about Chinese growth and think the short- term risk for Australian dollar is a bit too high for us,” Gareth Fielding, the chief executive officer at Quantum Global Investment Management in Zug, Switzerland, said on Sept. 17. “The rally has come a long way. We are a buyer if it falls below parity with the dollar.”
Australia’s economy was bolstered by the biggest resources bonanza since a gold rush in the 1850s as Chinese-led demand for iron ore, coal and natural gas surged in part because of Beijing’s 4 trillion yuan ($635 billion) stimulus package in 2008. Iron ore from Australia went into everything from skyscrapers in Shanghai to a shipyard in Dalian.
The Aussie rode the boom, advancing 48 percent against the dollar since Dec. 31, 2008, and 60 percent versus the euro through Sept. 21. Exports to China more than doubled to A$71.5 billion last year from A$32.3 billion in 2008, according to data from the Department of Foreign Affairs and Trade.
This rally made the Australian currency the most expensive among developed-nation currencies, based on the relative costs of goods and services as measured by the Paris-based OECD. The Canadian loonie and the New Zealand kiwi were each 21 percent overvalued versus the dollar using the same measure.
It also made it attractive to as many as 23 central banks from Brazil to Russia, according to data provided by the Reserve Bank of Australia under a Freedom of Information Act request by Bloomberg News. The share of global foreign-exchange reserves dominated in “other currencies,” which strategists said includes Australia’s dollar, rose to 5.2 percent in the first quarter, from 2 percent in 2007, according to the IMF.
“We suspect that there will be very heavy buyers of Aussie” over the long term, Todd Elmer, a currency strategist at Citigroup Inc. in Singapore, said in a phone interview on Sept. 11. “It makes enormous sense as a currency, in part because of commodities, in part because of higher returns, in part because of Australia’s more stable fiscal positions, than most major economies.”
Shipping costs rose last week, covering their running costs for the first time since July, as Chinese iron-ore buyers increased purchases after the nation announced plans for extra infrastructure spending.
RBA Governor Glenn Stevens predicted in August that the resource boom has at least another year to run before it begins to ease. Business investment accounted for about 17 percent of Australia’s gross domestic product in the first half of 2012 and is forecast to increase further in the next year, driven by mining projects, according to an RBA report.
Investors are showing concern that Australia’s economy may slow after the price of iron ore, which made up more than 20 percent of exports last year, dropped as much as 37 percent this year to the lowest level since October 2009.
Fortescue Metals Group Ltd. (FMG), Australia’s third-biggest producer, cut its spending plans by 26 percent as iron-ore prices declined. BHP Billiton Ltd (BHP), the world’s largest miner, delayed work at the Olympic Dam copper-uranium-gold project in South Australia last month, joining companies including Xstrata Plc and Rio Tinto Group in scaling back expansion.
“For Australia, the best news is behind us,” Adrian Owens, a money manager at GAM in London, said in a phone interview on Sept. 19. “China is struggling. In the short run, there’s been a few minor tweaks in terms of stimulus but that may not reverse a trend of slower growth.”
GAM, a unit of GAM Holding AG with $48 billion under management, is buying the Mexican peso, Owens said.
Barclays Plc, Morgan Stanley, Royal Bank of Scotland Group Plc and UBS AG forecast growth of 7.5 percent for China this year, the weakest since 1990. Pacific Investment Management Co. (PTTRX), which runs the world’s biggest bond fund, predicts a slowdown to 6.5 percent to 7 percent in the next 12 months.
China’s net exports and investment have “reached their limits,” Ramin Toloui, Pimco’s co-head of emerging markets portfolio management in Singapore, said in a Sept. 13 e-mail.
Australia’s economy grew 0.6 percent in the second quarter from the prior three months, according to a Bureau of Statistics report on Sept. 5, slower than the median estimate of economists for a 0.7 percent gain. Home-loan approvals unexpectedly fell in July by the most in five months.
“We are cautious” at these price levels for Australia’s dollar, Stefan Keitel, Credit Suisse Asset Management’s global chief investment officer, said in a Sept. 3 phone interview.
The firm, which has $385 billion under management, has sold Australian government bonds and is waiting for a “better entry level” as the currency’s valuation is “stretched” after a prolonged rally, he said.
The Aussie is trading about 30 cents higher than its average since exchange controls were scrapped in 1983. The RBA said Sept. 18 that it saw the strength of the local currency and slowing growth in China as risks to the domestic economy, signaling scope to cut interest rates.
After lowering the benchmark overnight cash-rate target by a total of 1.25 percentage points from October in an effort to boost growth, Stevens and his board left it at 3.5 percent for the past three meetings since June.
Traders see about an 84 percent chance policy makers will cut the benchmark cash rate by 25 basis points on Oct. 2, and a 97.6 percent likelihood of a reduction by year-end, interest- rate swaps show. Lower borrowing costs may make the currency less attractive to investors as they reduce returns on fixed- income assets.
“We’ve been seeing mining companies pulling back capital expenditure and iron-ore prices are still much lower than last year’s highs,” Mansoor Mohi-uddin, the global head of currency strategy at UBS AG in Singapore, said on Sept. 19. “The currency could definitely go below parity if the markets get more concerned about further easing.”
Gillard, the country’s first female prime minister, has seen her party’s poll ratings trail the opposition since after Australia’s 2010 election. She has pledged spending cuts and increased taxes to return the nation’s budget to surplus after four years of deficits.
The budget-surplus plan will reduce public spending and curb growth, Yoshisada Ishide, who oversees $14 billion at Daiwa SB Investments Ltd. in Tokyo, said in a telephone interview on Sept. 13. Ishide manages the biggest mutual fund focused on Australian dollar-denominated debt.
“The resource sector is one of the major pillars of Australia’s economy, and markets are cautious that demand for commodity exports will slow more evidently, which is negative for the economy,” Ishide said. He forecasts the currency will finish 2012 at parity to the U.S. dollar.
Standard Chartered Plc revised down its end-2013 forecast for the Australian dollar on Sept. 4, after having been jointly the second-most bullish forecaster in a Bloomberg survey of analysts as of July 1. It now predicts the Aussie will fall to 95 U.S. cents by the end of 2013 from a previous projection of $1.07.
“The Australian economy and its currency look vulnerable because of its exposure to China,” Peter Redward, a principal of Auckland, New Zealand-based Redward Associates Ltd. and former head of emerging-markets currency strategy at Deutsche Bank AG, said in an interview on Sept. 13. “We have yet to see the full impact on export values from the sharp fall in coal and iron ore prices. When it hits, the economy will slow, the central bank will cut rates and the Australian dollar will fall.”