BNY Mellon: Down Under

Mar 29, 2019

The bust to Australia’s commodity boom has rendered the AUD the worst performing (non-EM) currency in the G20 since 2013 (it has lost one third of its value to the USD). The currency has enjoyed some relative stability year-to-date; but the prospects of its recovery have taken a further setback.

Clearly, for a commodity currency sensitive to the health of the global economy, a market environment that is encouraging a flight to bonds is surely a troubling one. Certainly, investors are raising their bets against the AUD: CFTC data show that (non-commercial) net shorts have grown by 16,000 contracts since late February (with the latest build up the largest this year); and a net position of 51,900 contracts leaves ample room for a build up to the levels we saw last year (73,284).

The AUD has partly recovered from a slump at the start of the month, but the pressures behind this slide have not abated. At the end of February, PMI data out of China - Caixin and official - pointed to continued and troubling contraction in manufacturing activity, thereby putting an end to the three-month uptrend in the CNH. And given a strong, 84% inverse correlation between USD/CNH and AUD/USD since 2010, the fact that the CNH has since trended lower (albeit circuitously) is not without significance.

Indeed, the long-held depiction of the AUD as a China ‘proxy’ is well deserved. The AUD’s largest daily moves in 2018 were all instigated, directly or indirectly, by China-related news (Feb 2, June 14, July 11, Aug 31 and so on). And the close relationship between CNH and the AUD was once again highlighted this week.

On Wednesday’s European open, Bloomberg reported that at least two Chinese brokerages had halted new exchange-listed bond repurchases given fresh doubts over collateral. Having finally stabilised post RBNZ (see below), the AUD slid anew, tracking the CNH’s move lower closely, and only stabilising when the CNH turned around 50 minutes later.

Policy support in China may have become a double edged sword: whist weak data may bolster Chinese stocks given the reciprocal prospect of some form of PBOC intervention, it does so inconsistently, presumably amid plausible doubts over its efficacy. After all, China’s debt mountain – the product of years of monetary and fiscal largesse - has unlikely accrued without risks to loan quality. And yet the deleveraging that dominated 2017 and 2018 has now gone into reverse.

Another more subtle point of pressure on the AUD may be the RBNZ, if the Bank’s newly-instigated dovish bias has consigned the kiwi to a southerly course. Not that the RBA will be overly troubled by any rise in an AUD/NZD cross which has already fallen 7% since last autumn; and not that the case for a continued neutral stance is without merit (although the RBA might well have shifted stance informally).

No, this is based on a simple observation of the two currencies’ historically close relationship: without wishing to imply any causality, the fact is that whether we look back upon daily performance since 2000 or since 2010, the two currencies have put in the same directional performance against

the USD 75% of the time. And on the days they did not, the average divergence was a scant 0.03% points.

The RBA’s policy statements have remained pointedly insinuation-free on matters of currency and with AUD/USD still only trading 10% below its Millennium average, we see little reason why this will change should continued AUD-weakness come its way.