After a spell in the stratosphere, the Australian dollar is back in the spotlight following a sharp decline. But while the pullback has received plenty of attention, has it actually come as that much of a surprise?
Reports that George Soros may have made up to $60 million shorting the currency and calls by prominent hedge fund investors that it is set to “come down and hard” may grab the headlines, but for some time the Reserve Bank of Australia has been observing the disconnect between terms of trade, commodity prices and the Aussie dollar.
In what may otherwise have been a period of weakness, opposing forces such as quantitative easing, relative economic growth rates and global central-bank buying were some of the factors behind the strength of our dollar.
However, just as exchange rates can overshoot, so too can sentiment. Last year, calls were being made for an exchange rate of $1.20 or more against the United States dollar. Today, forecasts are getting pared back as quickly as the Australian dollar’s depreciation.
So what’s changed? In short, “tapering” and the changing fortunes of the US and Australian economies.
Beyond QE-infinity
It was only nine short months ago when the US Federal Reserve was seen to go “all in” with the third instalment of quantitative easing (QE3). At the time, US growth was stalling and unemployment was uncomfortably high, setting expectations for a prolonged period of easing and “QE-infinity and beyond”.
Clearly a lot has changed in a reasonably short space of time. Despite headwinds ranging from the fiscal cliff to “the sequester” budget cuts, the US economy has shown signs of improvement and delivered a series of encouraging employment numbers.
The progress was emphasised late last month following Fed chairman Ben Bernanke’s testimony to the congressional joint economic committee. Caught off guard, market participants are now second-guessing when the Fed will ease back off the throttle, causing an uptick in volatility across both equities and bonds – an interesting insight into a world without QE.
The taper and the transition
While the Fed is looking to “taper”, there is little doubt the Australian economy is in transition. Already under pressure from a softening domestic outlook, the taper talk seemingly cracked the Australian dollar.
With the Aussie now buying a paltry US$0.94, the general lament seems to be the fact we didn’t lock away a personal stash of US dollars, though we still see opportunity.
From a longer term perspective, the Australian dollar remains near historical highs and still provides attractive purchasing power. Locally, many investors have implicitly recognised this by seeking Australian companies with foreign (USD) earnings, yet surprisingly shy away from global shares.
Investors worried about the end of Australia’s boom could benefit from taking another look at the transition of other economies. For starters, the importance of cheap and reliable energy in the US should not be underestimated.
While a lower dollar may relieve some cost pressures for Australian companies, the shale-gas revolution is poised create a sustainable competitive advantage for industry in the US. There’s time yet for our dollar to drive us further.
Patrick Noble is a senior investment strategist at Zurich Investments
