Conclusion: Though we’ve seen a big move in recent months (AUD/USD -9.4% since peaking in late-July), we still think the Aussie dollar could go a lot lower vs. the U.S. dollar and, thus, we remain bearish on it over the intermediate-term TREND.
Position: Short the Aussie Dollar (etf: FXA). Long the U.S. Dollar (etf: UUP).
Yesterday, we added a short position in Australia’s currency, the Aussie dollar (AUD), to our Virtual Portfolio. This is not a new thesis for Hedgeye Macro clients, as we’ve been the bear in this market from a research perspective since 2Q and from a risk management perspective as early as July 27 (coincidentally the day the Aussie dollar hit an all-time closing price high vs. the USD), but it’s worth briefly rehashing the idea to those of you who may not be familiar.
The thesis behind our bearish view of Australia’s currency (particularly relative to the U.S. Dollar) is six-fold:
- Slowing Growth is Australia’s domestic economy leading to dovish monetary policy;
- Slowing Growth globally – particularly in key export markets;
- Housing Headwinds in Australia’s domestic property market;
- Deflating the Inflation both across the commodity complex and in Australia’s domestic economy leading to declining terms of trade and incrementally dovish monetary policy;
- Winner’s Risk a.k.a. mean reversion; and
- Correlation Risk bred out of Interconnected Risk Compounding (the trailing 3yr positive correlations to the S&P 500 and CRB Index are r² = 0.90 and 0.82, respectively).
Net-net, the confluence of these six factors should get the Reserve Bank of Australia to cut interest rates at some point over the intermediate-term TREND and reduce the Aussie dollar’s real yield advantage over the U.S. dollar. Admittedly, a lot of this is priced into various Aussie interest rate markets, but we see further room for decline in the currency market.
As we’ve mentioned prior, the Aussie dollar has a lot of potential for mean reversion – particularly if the institutional investment community continues to have liquidity headwinds. It’s worth noting that the AUD has appreciated +58.1% vs. the USD since the March ’09 SPX bottom – the second largest advance out of the 48 currencies and FX indices we track over this time period.
Regarding Australia’s domestic economy, Aussie economic data continues to come in largely sour on the margin. Manufacturing and Construction PMI’s are at 2009 [low] levels and the Services PMI has slowed in September as well. Business Confidence, which edged up in September, is likely to be contained absent further declines in the currency and an easing of corporate credit conditions – the latter of which we don’t see happening anytime soon (Aussie corporate credits spreads closed last week one basis point off of a 26-month high). We continue to think inflation – both at the consumer and producer level – will trend lower over the intermediate-term TREND and we’re seeing that in both the data and in market prices.
In Australia’s housing market, a benchmark rate cut(s) should be pushed through to mortgage rates and eventually help mortgage demand, which continues to make new all-time lows. This glaring lack of demand is causing Australian housing prices to deteriorate further, which should incrementally slow consumer spending growth in the coming months alongside rising joblessness (the unemployment rate has backed up +40bps since April). Some key metrics to consider regarding the headwinds facing Australia’s housing market over the long-term TAIL:
- Nearly 2/3rds of Australian citizens own homes (population = 22.5 million);
- Roughly 90% of encumbered households have variable-rate mortgages, which makes consumer finances incredibly sensitive to interest rate fluctuations;
- At 155% of disposable incomes, Australian households are more +16.5% more levered than U.S. households were just prior to the financial crisis (133%);
- Australia has the most unaffordable housing in the English speaking world, according to a January Demographia survey (6.1x gross annual household income vs. 3x in the U.S.); and
- A recent Zillow.com survey confirms the Demographia survey results: the median house price in Australia ($503k in May) is nearly 3x that of the U.S. ($184k in June).
Our proprietary quantitative levels on the FXA etf and the CRB Index (raw materials account for 60% of Australia’s exports) are below:
For more in-depth analysis behind this position, refer to the notes below (email us for copies). We’re also happy to follow up with a call for those looking for additional color:
- April 6, 2011: Aussie Dollar – Getting Long in the Tooth: We remain bearish on the Aussie dollar for the intermediate-term TREND and forsee a correction from its near all-time high (AUD/USD), primarily due to slowing economic growth down under in part aided by slowing growth in key export markets, which may lead to lower interest rates and more accommodative monetary policy.
- May 19, 2011: Aussie Dollar – Dancing ‘til the Music Stops: We expect the Aussie dollar to correct over the intermediate term as consensus expectations for an RBA rate hike(s) over the next 3-6 months are irrational due to a pending slowdown in domestic growth. Additionally, our 2Q Macro Theme of Deflating the Inflation is incrementally negative for the AUD as the Inflation Trade unwinds.
- July 27, 2011: We Wouldn’t Want to be Glenn Stevens Right About Now: RBA Governor Glenn Stevens could shock the Australian economy into a pronounced economic downturn by looking through the current slowdown and hiking rates within the next few months, but given recent economic data it seems more likely that the tightening cycle has peaked in Australia.