Aussie dives as China, Middle East weigh on sentiment

The Australian dollar fell sharply on Monday after weak manufacturing data from China revived fears about the pace of the country's slowdown and the impact on trade partners.

In late local trade, the Aussie was fetching US72.28¢ compared with US73.04¢ at the same time on New Year's Eve.

China's soft manufacturing sector will impact on markets this year.
China's soft manufacturing sector will impact on markets this year. Photo: Bloomberg

The local unit had been holding steady around US72.77¢ before the release of a private sector manufacturing purchasing managers' index showing another notable contraction in activity in December to 48.2 from 48.6 in November. 

The official PMI, published on Friday, had edged up from a three-year low of 49.6 in November to 49.7 in December.

In both cases, the index reading came in below estimates in Bloomberg surveys.

However, non-manufacturing PMI hit a 16-month high of 54.4, further reflecting China's transition from a manufacturing-heavy exporter to a services-led consumer economy.

Although potentially good news for Australian tourism, higher education and agribusiness, the economic re-engineering points to further softness in demand for Australian iron ore and coal, whose prices have been hanging around multi-year lows in recent months. 

The data hit a range of Asian currencies and sharemarkets amid fears that weak global growth and competitive currency devaluations – known as the "currency wars" – would persist in 2016 after a rocky 2015. 

Trading was suspended for the afternoon after China's benchmark Shanghai Composite Index lost 7 per cent, while the yuan lost about 0.7 per cent in offshore trade, leaving it at new five-year lows.

Monday's market shock came on top of broader unease around tensions between Iran and Saudi Arabia, and the impact on the oil price. This was expected to feed into foreign exchange markets this week. Energy exporters and safe haven currencies were likely to be the big gainers.

Saudi Arabia on Sunday formally cut diplomatic ties with Iran over reaction to the execution of a prominent Shiite cleric, intensifying long-running friction between the two powerful Middle Eastern states and oil producers.

Brent Crude was trading up 2.8 per cent at $US38.34 on Monday as future markets bet on supply disruptions.

Iran also faces fresh trade sanctions from the United States over a missile programme.

The yen, which is traditionally sought out by investors during periods of volatility, also firmed against the greenback, adding to steady gains since the US Federal Reserve in mid-December raised interest rates for the first time in almost a decade.

The Japanese currency spiked further on the weak Chinese data and in late trade was around 119.47 to the US dollar, compared with 120.40 on New Year's Eve, and after dropping as low as 120.75 at the weekend.

Top currency tips

Big themes such as the Chinese growth slowdown, Middle East tensions and investor positioning ahead of this year's referendum on Britain's European Union membership would often eclipse regular data releases as market drivers this year, Societe Generale strategist Kit Juckes said.

"Oil prices, China's soft manufacturing sector, the prospect of sovereign defaults, Middle Eastern politics, and nearer to home, Brexit polls, will all be of interest to markets in early 2016," he wrote on Sunday.

"What that means is that we will be braced for surprises and uncertainty in the weeks and months ahead, leaving the 'mundane' to take second place at times." 

His top three tips for currency trades this year include selling pounds sterling to buy yen, shorting the New Zealand dollar against its Canadian counterpart and selling the Swiss franc to buy the Swedish krona.

The first recommendation is a play on the British currency's over-valuation, along with negative sentiment around the so-called "Brexit". Meanwhile, the yen is expected to strengthen against most currencies after overshooting on its depreciation last year. 

The second punt is contingent on oil prices strengthening, while the third is a bet that Sweden's central bank will lose the battle to hold the currency low via monetary easing. 

"A slow burner, this trade," he said.

"A very expensive current account surplus versus a cheaper one, with two central banks which are both trying to resist currency strength."