It took a record low on the GBP/USD currency pair [British pound (FXB) versus the Australian dollar (FXA)] for me to realize that the Australian dollar has been in "stealth rally" mode this year. Depending on how one measures it, the Australian dollar has been quietly rallying since October of last year when iron ore prices lifted off a deep trough. Only the stubborn strength of the U.S. dollar has masked the underlying strength in the Australian dollar.
First, a chart of the U.S. dollar index shows that the dollar never suffered much from QE3. It will be interesting to see whether the Fed finds renewed dovish religion once (if) the index returns to its level right before QE2 was telegraphed to the market. Note in the chart below how the dollar promptly declined last time it visited those levels.
QE2 and QE3 have had little overall impact on the U.S. dollar now.
Next, a chart of the British pound versus the Australian dollar (GBP/AUD) clearly demonstrates that the Australian dollar is still on a historic run. Note that Monday's very poor UK industrial and manufacturing data (down 3% year-over-year for both measures was well below expectations for down 1%) sent GBP/AUD even deeper into previously unexplored territory.
GBP/AUD continues to bounce along historic lows - is a big breakdown coming to continue the downward trend?
Source: Dailyfx.com charts
For a while now, I have mainly fixated on AUD/USD, the Australian dollar versus the U.S. dollar, and how it correlates with the S&P 500 (SPY). It turns out that the U.S. dollar is the main currency that has consistently out-performed the Australian dollar over the past few months. At current levels, the Australian dollar has essentially made no progress against the U.S. dollar since the close of 2010 (2011 closed at the same level). In January of this year, AUD/USD failed to break the downtrend formed by the historic high set in 2011 around when iron ore prices were at their highest ever levels. The path downward has been very choppy but down nonetheless.
The Australian dollar is now down against the U.S. dollar this year, unlike its relationship with many other major currencies
Finally, here are charts of the Australian dollar against the euro (FXE), the ever-weakening yen (FXY), and the suddenly weakening Canadian dollar (FXC). For AUD/JPY in particular, note the approach to 100.
The Australian dollar is back to flat against the euro and seems poised to rollback much of its recent losses against the euro
This is a trade I recommended but abandoned far too early. Up nearly 25% since October!
Even Australia's commodity-rich cousin in Canada is starting to yield...
Source for charts except where otherwise noted: FreeStockCharts.com
For some context on this stealth rally, it helped me to review the last statement on monetary policy from last month, an extensive report that the Reserve Bank of Australia (RBA) produces on Australian and global macro-economic conditions.
The overall message again is that, all things considered, the Australian economy is OK and remains one of the strongest amongst the world's major economies:
"GDP growth is expected to be below trend at around 2½ per cent over 2013 before picking up to just under 3 per cent over 2014. These forecasts have been revised down since the November Statement, largely reflecting the slightly weaker outlook for mining and non-mining investment. Overall, the soft outlook over the next year or so reflects a number of factors: mining investment is expected to peak, both fiscal consolidation and the persistently high level of the Australian dollar will weigh on growth, and there is little sign of a near-term pick-up in non-mining business investment."
Trend growth would feel like boom times in many places around the world! As the RBA notes, the "crisis economies" are still quite sickly:
"The crisis economies, in particular, remain vulnerable to adverse shocks, including the possibility of social unrest in response to austerity measures."
Yet, the RBA explains this relatively good economic forecast for Australia in negative terms:
"The forecasts for growth over the next year or so reflect several factors: the expectation that the mining investment boom will reach its peak; the effect of both fiscal consolidation and the persistently high level of the Australian dollar; and little sign of a nearterm pick-up in non-mining business investment."
The RBA is now in the well-worn habit of suggesting the exchange rate should be lower given current economic conditions. Here, it explicitly notes that the currency must get weaker in order for the non-mining sector to improve:
"…when, and by how much, non-mining business investment might pick up remains particularly uncertain, including because of the high level of the exchange rate."
The currency's strength persists even as financial markets are anticipating further reductions in rates:
"Financial markets expect some further easing in monetary policy during 2013. Rates on overnight indexed swaps (OIS) currently imply a cash rate target of around 2.50 per cent by the end of the year…"
These expectations are very rational given the RBA's boilerplate notice in its recent interest rate decisions that it stands ready to keep cutting interest rates:
"The current inflation outlook would afford scope to ease policy further, should that be necessary to support demand."
I suspect one of the largest factors in propping up the Australian dollar is the rapid recovery in iron ore prices, Australia's #1 export by a large margin. While forecasts abound for lower prices in the second half and beyond, the market is seemingly unconcerned…
"The sharp increase in the price of iron ore in recent months does not appear to have materially affected investment plans to date, in part because the general expectation is that prices will not be sustained at these levels. Nonetheless, given the magnitude of resource projects already committed, particularly liquefied natural gas (LNG) projects, mining investment is expected to remain at an elevated level for a couple of years."
Given recent history, this economic activity, along with low interest rates, seems poised to maintain Australia's relatively high GDP growth rate.
The persistent strength in the Australian dollar that is part of this stealth rally is indicative of a market that is waiting to see real evidence that the Australian economy is starting to suffer from the strong currency. In other words, it is very likely that the currency will not weaken notably until economic data forces the issue. Until then, the Australian dollar seems likely to continue exhibiting strength against most of the major economies where interest rates are near or at zero.
Be careful out there!
Additional disclosure: In forex, I am short AUD/USD, short GBP/AUD