Dollar "defying gravity" as forecasts lift

Treasurer Wayne Swan says the Australian dollar is “defying gravity” as commodity prices fall and analyst forecasts lift.

It comes as the trade-weighted index for the Aussie reached its highest level since 1985 yesterday, spurring analysts to reverse course after cutting year-end forecasts for the currency.

Policymakers and executives at the Bloomberg Australia Economic Summit in Sydney yesterday singled out the local dollar’s strength as the biggest challenge for business, while conceding there’s little that can be done to restrain it.

The dollar will likely trade at $US1.03 by December 31, up from estimates at the end of March of $US1.01, according to the median of 43 forecasts compiled by Bloomberg.

“The global economy requires the big economic engines to grow so we can all grow together, and if that requires expansionary monetary policy because fiscal policy has reached its limits or can't be implemented then so be it,” the treasurer said.

The economy expanded 3.6 per cent in 2012, the fastest pace in five years, while employers added 71,500 jobs in February, the most in almost 13 years, government data showed last month.


But clouding the outlook, BHP Billiton chief financial officer Graham Kerr told a Bloomberg economic summit yesterday he expects annual economic growth in China to moderate toward 6 per cent, and that prospects in its largest customer present the company's main business risk.

The dollar was at $US1.055 this morning and has remained above $US1 for a record nine-month stretch.

The RBA's trade-weighted index climbed to 79.9 yesterday, the highest level since 1985. The index tracks the dollar against the currencies of 21 nations that account for at least 90 per cent of the country's commerce.

"The Australian dollar meets our criteria of a strong currency and we do believe it will be an important beneficiary of continued central bank reserve diversification," said Jonathan Lewis, New York-based chief investment officer and a founder of Samson Capital Advisors LLC.

"We believe this is a very long-term investment theme."

'Decimating' manufacturing

Australia’s defiance of the global slowdown is now backfiring on manufacturing after the currency soared 75 per cent against the US dollar and 87 per cent versus the yen from its low in October 2008.

Terry Davis, managing director at Coca-Cola Amatil Ltd., said the Aussie is “decimating” manufacturers, while Robert Mead, head of portfolio management in Sydney at Pacific Investment Management Co., said businesses are deferring spending.

The government and Reserve Bank of Australia say the cash flowing into the economy - fueled by quantitative easing in the US and Japan - is beyond the control of policy makers in a small nation.

“That’s the hand that the world has dealt us,” RBA Assistant Governor for economics Christopher Kent said at the summit, reiterating that the central has no plans for intervention to weaken the Aussie.

“Businesses in a number of industries are under quite a deal of pressure -- part of that’s because of the exchange rate.”

AAA Rating

UBS Global Asset Management expects the Aussie to stay high as investors "just love" the yields it offers.

Australia is one of eight nations that hold stable AAA grades from all three main credit-rating companies.

Its 10-year sovereign bond yields are 1.74 percentage points more than the average for the other seven countries.

With $270 billion ($US285 billion) in sovereign debt, Australia has the second-largest government bond market among stable AAAs.That compares with $US11.6 trillion for the US, which Standard & Poor's reduced to AA+ in 2011, and $US9.2 trillion for Japan, graded AA- by S&P.

"We are seeing corporates, not just from Asia but from Europe, thinking: Where are we going to put our money?" Anne Anderson, head of Asia-Pacific fixed income for UBS Global Asset Management, said at the summit.

Clients in Europe "look at the yield and they cannot believe that our bond yields are so high," she said.

Diversifying Reserves

The Federal Reserve and the Bank of Japan have pledged to purchase about $US160 billion in bonds between them every month to spur growth, pursuing so-called quantitative easing that some investors speculate will debase their currencies.

Central banks for the first time used their reserves to buy about the same amount of currencies from Australia and Canada as US dollars at the end of last year, according to International Monetary Fund data released March 29.

A category the IMF calls "other currencies," which strategists say is dominated by the Aussie and Canadian dollars, rose to a record 6.1 per cent of the $US6.1 trillion in allocated global reserves. China, the world's biggest reserve holder, doesn't report the data to the IMF.

Aussie 'Floor'

The IMF said in November it would consider separately identifying allocations to the Aussie and Canadian dollar in its Composition of Official Foreign-Exchange Reserves report.

That would influence central bank decisions to invest in these currencies, 67 per cent of those polled for the RBS Reserve Management Trends 2013 report said.

"Ongoing demand for AAA rated credit may put a floor under the Australian dollar," said Darcie Sunnerberg, a vice president and sovereign analyst at Boston-based Loomis Sayles & Co. "Overall, fundamentals would suggest a weaker Australian dollar in the short-term," she said..

Rate Forecast

Barclays Plc and Credit Suisse Group AG are among forecasters saying the currency will drop below $US1 this year as slowing mining investment damps growth. Gross domestic product will probably slow one percentage point to 2.6 per cent this year, according to the median forecast of economists polled by Bloomberg News.

National Australia Bank business conditions gauge slumped to its weakest in almost four years, an April 9 report showed. The nation's unemployment rate will rise to 5.75 percent this year from 5.4 percent in February, the bank said.

To arrest the slowdown and support the economy as a record mining investment boom slows, the RBA will cut borrowing costs to a record low 2.75 per cent in the third quarter, economists in a separate survey estimate.

The RBA reduced rates by 1.75 percentage points since November 1, 2011, to rebalance the economy away from mining and toward industries including construction and tourism.

'Quality Place'

"There's room to cut should that be necessary," RBA Assistant Governor Christopher Kent said yesterday at the Bloomberg Summit.

Year-end forecasts for the Aussie range from Saxo Bank A/S's 88 cents to $US1.12 at Royal Bank of Canada, according to data compiled by Bloomberg.

"We're hedged and we'll stay that way until we see fundamentals change in a bigger way," said Daniel Janis, a global fixed-income portfolio manager who helps oversee about $US15.5 billion at Manulife Asset Management in Boston.

"We like the quality of the government bonds because we don't have to worry from a ratings standpoint, so it's a quality place holder in our portfolio."

Janis estimates the Aussie will trade in a range from parity to $1.06.

Offshore investors' holdings of Australian sovereign debt swelled by $23 billion to $207 billion last year and foreign deposits in domestic banks rose to a record, official data show.

"The main theme is that China's still got this diversification bid out there for the Australian dollar and that has limited declines in the currency above the parity level," said Adrian Foster, the Hong Kong-based head of financial- markets research for Asia at Rabobank.

Rabobank, the most accurate firm at picking the Aussie over the past four quarters according to data compiled by Bloomberg, forecasts it will end the year at $US1.06.