The Aussie Divergence: Who leads and who follows?

Quotable

“… I will begin with two key assumptions. The first is that the fundamental imbalance in China is the very low GDP share of consumption. This low GDP share of consumption, I have always argued, reflects a growth model that systematically forces up the savings rate largely by repressing consumption, which it does by effectively transferring wealth from the household sector (in the form, among others, of very low interest rates, an undervalued currency, and relatively slow wage growth) in order to subsidize and generate rapid GDP growth.

“As a consequence of this consumption-repressing growth model, Chinese growth is driven largely by the need to keep investment levels extraordinarily high. What’s more, the very high growth rate in investment, combined with significant pricing distortions, especially in the cost of capital, has resulted in massive overinvestment and an unsustainable increase in debt. China cannot slow the growth in debt and resolve its internal economic problems without raising the consumption share of GDP.

“My second major assumption is that China must and will rebalance in the coming years – its imbalances, in other words, cannot get much greater and we will soon see a reversal.”
                                    Michael Pettis

Commentary & Analysis
The Aussie Divergence: Who leads and who follows?

The Reserve Bank of Australia kicked the door wide in its last meeting, sealing the deal on expectations for a coming interest rate cut Down Under. It seems growth in Australia may be in some trouble. Until recently the Australian dollar was acting as a pure risk asset–tracking dead on the US stock market. That has changed and there is a big divergence developing between the price series. So, who leads and who follows?

I guess we can say the factor that closely fuses stocks with the Aussie dollar is a place named China. If the Aussie better reflects growth prospects there more rapidly does the discounting in the stock market than this correlation could have some significance. I think it does, but correlations are what they are and not exactly perfect indicators.

So, does the price series comparison in the chart below tell you anything? More specifically, does it tell you it is time to…

A) buy AUD/USD
B) sell US stocks
C) forget about it

AUD/USD versus Dow Jones Industrial Average Daily:

The last time this type of divergence developed back in August 2011, stocks led. Small sample size indeed…but stay tuned.