Currency Of The Month: Just Ask The All-Powerful “Aus”

Currency investors may look favorably on the Australian dollar (AUD) for a number of reasons, including its diversification benefits as the “commodity currency,” the stable economy and government underlying the currency, or the relatively laissez-faire monetary policy of the Reserve Bank of Australia (RBA). But, the “Aussie” has also been a long-time favorite of the Daily Pfennig® newsletter for measuring the temperature of global economic growth prospects, primarily due to the Australian economy’s importance as a major worldwide provider of raw materials for most manufacturing industries.

The Australian dollar was introduced in 1966 after the country abandoned the Australian pound, a holdover from the days of Australia’s inclusion as a British colony. Originally named “The Royal” after a heated internal debate among other colloquial names, including the Oz, Boomer, Roo, Kanga, Kwid, Champ, and Emu, the country eventually settled on the dollar following almost universal disdain for the “Royal” name. After a brief period of maintaining its peg to the British pound, the AUD eventually delinked from the pound in 1967. Shortly thereafter, the AUD successfully passed its first test as an independent currency, maintaining its value against the U.S. dollar when the British pound was devalued in 1967. This marked the beginning of the AUD’s climb to where it is today: the 5th most commonly traded currency in the world.1

Back in my Mark Twain Bank days in 1992, the Australian dollar caught my attention as a currency well-positioned as a “picks and shovel” investment for periods of global expansion, particularly given the country’s position as a leading exporter of coal, copper, aluminum, gold, and natural gas. Today, nearly 20% of Australian gross national product (GDP) is represented by export activities, with the country’s largest trading partner, China, absorbing almost one-third of all export activity from the country.2

Australia was the world’s second-largest coal export economy in 2012 and the third-largest exporter of liquefied natural gas (LNG) in 2013.3 Those are two critical raw materials for the production of electricity. Since electricity is all but essential for economic growth, it should, therefore, come as little surprise that cycles in the Australian dollar tend to correlate relatively closely to global production activity (Figure #1).

Fig. #1
AUD/USD Exchange Rate vs. YOY Industrial Production (01/1992-11/2015)

Source:, World Bank Global Monitor.

As such, the AUD provides a unique barometer for measuring global growth prospects. The beauty and the curse of the Australian dollar is that as the global economy moves through expansion and contraction periods, so does the value of the currency. Over the past few years (as evidenced by Fig. #1), the Australian dollar has struggled to find a firm footing against the USD, particularly given China’s economic slowdown. Nevertheless, the Australian government has labored to maintain the sound fiscal and monetary policies needed to help support the value of the Australian dollar during periods of cyclical slowing.

Australian Economic Overview
Recognizing that its heavy dependence on China would require a refocus on internally generated growth, the Australian government identified plans to help drive greater domestic consumption demand through employment and productivity initiatives. In the most recent monetary policy statement by RBA Governor Glenn Stevens, he stated that despite a continued contraction in mining investment, he believes overall GDP growth in Q1 of 2016 advanced relative to 2015, consistent with positive developments in the labor market and increases in business lending.4 (Figure #2)

Fig. #2
AUS GDP Growth (Seasonally Adjusted Q1/1995-Q4/2015)

Source: Australian Bureau of Statistics, 2016.

While the projected 3% growth figure illustrated remains at the low end of 1.25% to 5.5% rates of growth experienced over the past two decades, it is an indication that the economy continues to move toward self-sustainability. Moreover, Australia’s recent employment figures indicate that the country’s unemployment rates remain at a manageable 5.8%, after a surge in job creation at the end of 2015 helped to reduce some of the labor slack within the economy,5 although with admitted reduction in labor participation rates as well.

Inflation rates within the Australian economy have also remained manageable, falling below the RBA’s target of 2%, yet above 1.5%, indicating price levels remain in a Goldilocks range – that is, not too hot and not too cool (Figure #3). In my opinion, the current rate of inflation at just below 2% keeps pressure off the RBA to join the ongoing race of global central banks to move to negative interest rates by lowering interest rates below the current 2% level. The RBA’s inaction on lowering interest rates has likely provided the Australian dollar at least some level of support relative to the U.S. dollar.

Fig. #3
Australian CPI (12/2005-12/2015)

Source: Australian Bureau of Statistics, 2016.

There is one key area of concern with respect to the Australian economy that investors should be wary of, and that is the current account deficit. Australia’s current account balance was about -$50 billion AUD, or roughly 3.4% of GDP at the end of 2015. This is one of the largest accumulated current account deficits in the world, ranking as the fourth largest among 197 countries.6 The country’s trade deficit has certainly been a primary contributing factor for this imbalance, with Australia’s February 2016 posting of a -$3.4 billion AUD deficit further compounding the $3.2 billion AUD trade deficit deterioration posted in January 2016.7

Outlook For The AUD
Clearly, Australia’s trade deficit issues will be a dark cloud hanging over the Australian dollar for some time, which may linger until such time as the Chinese economy begins to recover from its own growth recession. The risk for currency investors, of course, is that the RBA decides to join the crowd by lowering interest rates to effectively devalue the Australian dollar to help stimulate export activity and growth. At this point in time, the RBA has chosen not to succumb to the temptation of currency debasement by reducing interest rates, helping to further solidify its reputation for being a non-interventionist central bank, and maintaining its membership in my “Prudent Central Bank Club.” Yet, this perceived risk might, nevertheless, hang over the AUD as long as the trade deficit continues to deteriorate.

As with many investment opportunities, timing is everything. Successful investing is not just about finding a good investment, but identifying that opportunity at the right price and the right time. As far as currency investments are concerned, the Australian dollar has many attributes that I find attractive in a core currency holding, such as diversification benefits, prudent fiscal and monetary stewardship, liquidity, and a stable underlying economy and government. While these fundamental strengths should help to reduce further erosion of the Australian dollar’s value through the global economic cycle and internal economic rebalancing underway, the currency will likely remain one catalyst short of returning to its former strength.

Until the next Daily Pfennig® edition…

Chuck Butler
Managing Director
EverBank Global Markets Group