- Lower commodity prices and slower Chinese demand may have been anticipated by the Australian Dollar traders.
- European and Japanese monetary stimulus will result in large amount of low interest funds seeking the higher returns in Australia.
- Strong properties market in Australia means the Reserve Bank cannot lower the current bank rate.
For months, market analysts have been touting the slowing Chinese economy and the negative impact it will have on the much smaller Australian economy. Since China is the biggest market for Australian iron ore, and a big buyer of coal, this story has had some legs. This, however, is old news. Markets look toward the future, and continually assess the impact of anticipated future events. Rarely do markets discount the same future event twice. This helps explain the old adage "buy the rumor and sell the fact."
Speculators aggressively sold the Aussie, and had a short of almost 87K futures contracts according to a January COT report. Like most trades when the spec crowd is heavily committed to one side, the short A$ trade did not work. A steady rally to the .94 handle has followed. Now, for the Aussie, is this as good as it gets, or is there more?
Their economy has produced solid growth in the 1st quarter, in part thanks to good weather and soaring iron ore exports. Traders are anticipating the commodity and mining segment of the economy will slow in the 2nd half of the year. It was reported Friday the ore price delivered to China made a new low this week, trading down to $90.90 per MT. Further, it is reported the inventory in China is 106.5 million Metric tons. With that much inventory, and questions concerning the use of the ore as collateral for loans, perhaps for more than one loan, it seems likely there will be new lows forthcoming in the ore market. But again, has the market discounted this?
The fear of a future slow down remains, but the employment numbers released yesterday were positive. Despite a minimum wage of A$ 18.70 per hour, the unemployment rate remained steady at 5.8%. This was partially the result of a drop in the employment participation rate to 64.6 from 64.7 last month. Still, employment is a lagging indicator.
Aussie traders may be looking for guidance in the wrong direction. The Chinese slowdown is a threat to the economy, but a bigger factor in the value of the A$ may be demand for Australian bonds by the Japanese. As we noted earlier, part of PM Abe's plan to save the Japanese economy from continued deflation is to encourage investors to shift from stodgy low yielding government bonds to riskier assets. Reallocation of the assets will result in sales of the government bonds and buying Japanese as well as foreign stocks and bonds. This will also involve sizable yen selling.
The total value of Government Pension Investment Fund, the Postal Saving Fund, and private insurance retirement plans may exceed $3 Trillion. As reported in the earlier article, Nomura Holdings Inc. said the shift in the GPIF will result in the purchases of $200B of foreign assets, both stocks and bonds. If the GPIF is moving money, you can be sure the private insurance companies are doing the same.
Contrary to expectations, the yield on the Japanese Government bonds has not increased. The Bank of Japan is probably the only buyer as the funds sell the JGBs. Some of the money is being shifted to Japanese Index funds but there is also a search for bond yields in the world markets.
Currently, the Australian yields are attractive. Ten year bonds yield 3.78% and the fifteen year yield is 4.15%. This compares to .59% in Japan for the ten year or 2.82% in Italy. As a result, the flow of Japanese buying of Australian bonds has started. Bloomberg reports:
"The tide has turned for Aussie now that the Japanese have come back to the market," Geoffrey Kendrick, Morgan Stanley's head of Asian currency and interest-rate strategy in Hong Kong, said by phone on June 10. "Their switch back into Aussie bonds signals a turn in global long-term investor sentiment. More will follow."
Morgan Stanley regards Japanese investors, the biggest holders of Australia's long-term debt after U.S. and U.K. funds last year, as a bellwether for the Aussie. Drawn by the Reserve Bank of Australia's decision to stop lowering interest rates, Japan's money managers have been net buyers every month this year through April, purchasing a total of 356.4 billion yen ($3.5 billion) of the country's sovereign debt.
Demand from Japanese investors for the world's highest-yielding top-rated debt will help push the Aussie to $1 this year for the first time since May 2013,
Next week we get a report of the last Board Meeting of the RBA. The bank rate remains unchanged though there may be some grumbling about the negative pressure on the Aussie economy if the A$ moves higher. The Board has a dilemma. Real estate prices are quite high. Australia is rated as the third most expensive country in the world to live, but a lower rate would only exacerbate the real estate bubble. There is no reason the inbound flow into the Aussie debt market will slow.
Click to Enlarge AUDUSD Daily Currency Chart
Continued strength in the A$ looks likely. There might be some resistance in the .9460/.95 area. Should we clear that area the next target should be the .98 handle.
For those who wish to buy the AUDJPY, I have some reservations. First, the yen market is already loaded with shorts. It may work but it can get messy if there is a short squeeze. Further, there are now more global trouble spots than there have been for years. In times of crises, specs tend to seek the yen for safety. I disagree with this trade but the market does not listen to me.
The geopolitical turmoil may present the opportunity to buy the A$ lower than current levels. Longer-term, the A$ should work higher.