The recent bounce in the $A against the $US might suggest to some that a revaluation of the $A is underway. We beg to differ, although we do acknowledge that the rate of devaluation of the currency will be much slower from this point.
We use a number of charts below to illuminate our view.
The following chart tracks the movements of the $A over the last ten years. The elevated nature of the $A from 2011 to 2014 is clear to see. Prior to 2008, the currency was fairly steady trading below US80 cents.
Figure 1. Australian dollar
Source. Trading Economics; OTC Interbank
The elevated $A was in response to a number of factors. Understanding the influence of each of these factors gives us an insight into the outlook of the $A.
The next chart is telling because it suggests that the $A is ultimately directed by the national trade account.
Figure 2. Australian Trade Balance (sa)
Source. Business Insider
The weakness in the trade account prior to 2007 corresponded with an exchange rate of about US 80 cents. The $A rallied quickly at the start of the resources boom, and Australia posted a trade surplus for much of 2008.
The $A collapsed during the GFC as commodity, currency and bond markets went into turmoil. Holding $A was the last thing on the minds of major international investors.
However, the massive Chinese fiscal stimulation of 2009 directly led to the sustained jump in iron ore and coal prices. Australia’s two largest exports rallied to historic highs and took the trade account into surplus through 2010 and 2011.
Commodity price rises were matched by massive production increases following a sustained capital investment spend. This capital investment spend resulted in a lift in capital imports. The decline in the trade account in 2012 partly reflected the capital imports required to support the ramp-up of the LNG production that is commencing in 2015/16/17.
Figure 3. Australian Bulk Commodity Exports
Source. Bureau of Resources and Energy Economics
The capital investment cycle was noted by market commentators, and markets generally ignored the Australian trade deficit of 2012 on the assumption that as capital investment slowed, the trade account would soon balance. This played out in 2013 as Australia ever so briefly posted a trade surplus.
However, the commodity rot accelerated in earnest from mid- 2014 as all commodities and metals moved into steep decline. Supply had been greatly expanded and a slowing in growth in China resulted in a downward cascade of prices. Importantly, the price of oil collapsed and added to deflation concerns across Europe. This resulted in a further downward adjustment to demand and commodity market prices.
Figure 4. Commodity Market Prices
Source. Fairfax Media | Chartbuilder; Data: Bloomberg
Thus, we maintain our view that it is trade account, influenced by Australia’s terms of trade, that is the best guide to the $A.
As for the effect of relative international interest rates on the $A we are less convinced. The final chart tracks the USDAUD against the cash rate settings in the United States.
20151123_Blog_Fig5Figure 5. US Fed rate (%) vs USDAUD
Source. Fairfax Media | Chartbuilder; Data: Bloomberg
Our observation is that the adjustment to the cash rate in the US usually pre-empts a similar directional move in the $US. However, the reaction usually takes a few years to play out.
Importantly, over the last 18 months, the lift in the $US has occurred independently of the cash rate. Our conclusion is that the $US is now reacting to weakness in commodity prices and markets. That is the same cyclical influence on the $A.
A final point regarding the $A and our trade account is covered in the following table.
While the opportunity is significant to develop agricultural and food exports, the statistics suggest Australia has been too slow in developing these industries.
In 2014, rural exports amounted to $42.6 billion, an increase of 7% over 2013. Rural exports amounted to just 14% of our total exports.
20151123_Blog_Fig6Figure 6. Australian Exports by sector
Sources: ABS; Efie
For rural exports to balance Australia’s trade account (based on current commodity and metal prices), it would require a 100% increase in production. Clearly that could only occur over decades and it would only occur following a sustained capital investment spend similar to that seen in the iron ore, coal and LNG industries.
It is unfortunate that Australia has no significant agriculture companies that can raise and attract the necessary capital required. It is a lack of national and corporate focus that is the biggest impediment to sustained growth in agriculture in Australia.
Therefore, our view is that the $A will remain relatively week until capital is mobilised to focus on non-commodity exports. Based on recent history, we suspect that most of this capital will flow from Asian investment groups – if the Australian Government allows it.
It is an unfortunate truth that Australian capital has little patience for long term investment, and that is another reason why the $A will remain weak and the Australian economy will be slow to develop new dynamic exporting industries.