The idea to address the concept of currencies tied to their current account came from a section featured in Friday’s (September 4th, 2015) Bloomberg Brief Economics Asia:
Here is a brief analysis of the Australian dollar. A more technical analysis of the Canadian dollar is being prepared. The following analysis has been presented with the USD as the secondary currency.
The Australian dollar has consistently been weakened against the greenback over the past 12-15 months.
Conventionally, analysis on the Australian dollar has been AUD/USD, such that the recent breach of 70 cents against the greenback has sparked a bit of concern for the lonely nation. Of recent, the AUD/USD touched near 60 cents against the greenback back in 2008-9 and recovered well into 2013 until it dropped back down to the current September 7th quote of 0.6933:1. Many analysts will be looking for a support level at the current quote.
As you can see from the below chart, the Australian dollar has been popular among currency traders as Australia presented comparatively high interest rates. However, as one of the highest-yielding G10 currencies, volatility in the currency insinuates that higher returns and losses can be made on currency swings. Furthermore, although a ‘weaker’ Australian dollar may boost domestic exports, this alternatively makes imports more expensive for domestic consumption. Thus, a value vs. substitution effect should weigh upon analysts minds as to whether the increased weakness of the Australian dollar will boost exports enough to sustain expected economic growth.
Tamara Henderson of Bloomberg Intelligence highlights three factors that could prevent the AUD/USD from falling further below the 70 cents against the greenback.
- China’s share of Australian exports has risen significantly over the recent 5-year period as Australia has seen a 73% rise in Chinese tourists between 2012-2015. Thus, as China moves towards more of a consumption-based economy, Australia should be on the receiving end as well.
- The prospect of the Reserve Bank of Australia (RBA) to lower interest rates further in order to stimulate consumption is limited. Household debt, as a share of income, stands at an all-time high of 156%. Furthermore, persistent low-interest rates cause destabilizing asset bubbles which lead to an oversupply (potentially solved by a weakening of the currency) and discouragement of consumption by savers. The RBA has already announced that inflation expectations are already above the bank’s inflation target and thus a further drop in interest rates (which would potentially push up inflation further) would be unlikely.
- The US implication is twofold. As the Fed is destined to hike upwards its Fed Funds Rate, this will further strengthen the USD and assist Australian exports. However, if the Fed fails to lift interest rates, this may cause less panic in the market and thus increase the risk appetite of investors and help lift currently depressed commodity prices. This could boost the export exposure of the Australian economy.
In conclusion, I agree with Bloomberg’s premise that a nation’s current account is potential proxy for the future exchange rate demand; however, the Balance of Payment’s financial account needs to be taken into consideration, especially in terms of 3-6 month fluctuations, if the nation’s central bank were to intervene at some point to keep a temporary/permanent exchange rate target zone.