The Aussie Dollar Soars, Central Bank Shrugs

At a time when nations from Japan to Brazil are struggling to keep currency gains from damaging their economies, Glenn Stevens, governor of the Reserve Bank of Australia, the central bank, is taking the road less traveled. He's welcoming a stronger exchange rate.

Australia's dollar (nickname: the Aussie) has advanced 17 percent against the greenback since the end of June, the biggest gain of the 16 major currencies tracked by Bloomberg. It recently reached parity with the U.S. dollar for the first time since July 1982. Stevens figures a combination of a stronger currency and higher interest rates—he's hiked rates seven times in the last 14 months—will quell the country's inflation and keep growth steady.

Prospects for the Aussie, as well as the central bank's hands-off attitude, are tempting some of the world's biggest bond investors to pile into the nation's debt, even though Stevens has signaled more rate increases may come. "The Australian dollar is among what we're calling the world's new safe havens," says Jonathan E. Lewis, founding principal of New York-based Samson Capital Advisors, which manages $6.9 billion and specializes in bonds and currencies. Lewis has twice the percentage of Australian dollars in client accounts than what's contained in the benchmark index Samson uses to gauge its performance. Tokyo-based Kokusai Global Sovereign Open, Asia's biggest bond fund, boosted its investment in Australia to a record 15 percent of assets this year. The Australian government's Nov. 10 auction of debt maturing in July 2022 attracted bid volume four and a half times greater than the amount of available securities.

Investors love the appreciating currency and the benchmark rate of 4.75 percent, especially when compared with rates near zero in Japan and the U.S. They don't seem too concerned about the problems forcing Stevens to hike those rates. China's appetite for Australian iron ore, coal, and other commodities has created a red-hot mining sector that is luring workers away from other parts of the economy and driving up wages.

The Aussie has dipped recently on fears that the Chinese government would try to cool off its own economy. Yet the International Monetary Fund predicts China's economy will grow 9.6 percent next year, which should be enough to keep Australian mines humming. The IMF expects that Australia's economy will expand 3.5 percent next year from 3 percent in 2010. What's more, when Australia sells its ore and coal, the deals are priced in U.S. dollars, so the value of Australia's currency does not affect the price for foreign buyers. Chinese imports of iron averaged 51.5 million tons a month this year and last, compared with 37 million tons monthly in 2008.

Could the central bank forsake its neutral stance and intervene if the Aussie gets too strong? Ken Leech, head of the global investment strategy committee for Western Asset Management, Legg Mason's bond unit, says he doesn't think the Australians will intervene. Since letting their currency first float freely in 1983, the Australians have been generally reluctant to jump into the markets to prop up or restrain the Aussie dollar.

The Australian currency may also be too hot not to cool off. Its advance has already made it the world's most expensive currency based on purchasing power parity, a measure of the cost of goods relative to other countries. The gauge shows the Aussie is trading at a 30 percent premium to the greenback, according to data compiled by Bloomberg. "It's very overvalued, and it's unlikely to remain that way for a substantial period," says Lee Hardman, a foreign exchange strategist in London at Bank of Tokyo-Mitsubishi UFJ. For investors tired of meager yields elsewhere, it's a good ride while it lasts.

The bottom line: Australia is luring investors, who like the country's high interest rates and strong dollar. The central bank needs to keep inflation in check.

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