The year 2009 has been a kind one for Australia. While other nations were languishing in GDP hell throughout the year, Australia was able to avoid a technical recession and actually post growth. The country’s relatively good economic situation coupled with optimistic global news here and there helped give the RBA the incentive to hike rates all the way to 3.75%.
Much of the bank’s decision has to do with Australia’s recovering labor market and a robust export demand from China. The whopping 19.2% surge in China’s industrial production in November has helped buoy Australia’s raw materials exports. And with Australia’s unemployment rate falling to 5.7% from 5.8%, we may see stronger spending as more people now have jobs.
The combination of increased risk appetite, carry trade, and a positive fundamental outlook gave the chance for the Australian dollar to snag this year’s “Best Performing Currency” award (out of the major currencies).
Now, if you’ve been to an Aussie bar, you’d probably hear some Australian trader brag about these facts. He’d probably tell you, “Just get your hands on some Aussie mate… that’s easy money right there!” But let me be the one to tell you mate, that things aren’t looking so sunny for the Aussie right now…
For one, the GDP reading for the third quarter this year was less-than-stellar. The Australian economy reportedly grew by a mere 0.2%, way below the previous quarter’s 0.6% growth and a hairline close to economic contraction. As we all know, the Aussie has been banking mostly on strong GDP readings each quarter. After all, Australia was enjoying the limelight after it dodged a technical recession this year. It seems that the Australian economy could be on the brink of losing this edge…
Prying into the GDP components would reveal that the third quarter growth was spurred, not by increased economic activity, but by government spending. The Australian government spent more on roads, infrastructures, and schools during the third quarter, effectively boosting government spending by 0.7%. What dragged the quarterly GDP lower was the 2.3% downturn in exports, which was diagnosed as a side-effect of the Aussie’s strong rallies.
The most recent meeting minutes of the RBA is also putting some downward pressure on the Aussie’s value. According to the minutes, the recent tightening measures will be sufficient to keep the central bank’s inflation target in check at 2-3%.
Despite all these new developments, some believe that the Aussie will manage to keep its head above water just because of its yield advantage over the other currencies. In a carry trade, traders borrow funds from a low-yielding currency like the US dollar or the Japanese yen, each yielding 0.25% and 0.10%, respectively. These ‘cheap’ currencies are then used to fund their investments on higher yielding ones like the Australian dollar. This practice is thought to be a significant factor in driving exchange rates higher.
I, however, beg to disagree (respectfully, of course). Simply relying on yield to push currencies higher further is silly in my book as the concept of carry trades require stability in exchange rates and interest rates at the very least. For five straight weeks, the Aussie has been beaten and knocked out on the mere speculation that the Fed could tighten rates sooner than expected, while at the same time, the RBA would pause with their rate hikes. Imagine what could happen to the Aussie next year, when other central banks all over the globe actually start tightening rates?
Combine this with the unimpressive data that have been coming out plus the recent gains by the greenback, the Aussie could experience a world of pain come 2010. Then again, the RBA could be hiding a few more tricks up their sleeve to make sure that New Year starts with a bang!