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Takeaway: This is not a sound buying opportunity; in fact, we’d welcome a continued squeeze in the Aussie dollar as an opportunity to short into.

SUMMARY BULLETS:

  • A structurally depressed growth outlook should continue to dictate Australian monetary and fiscal policy over the long-term TAIL – compressing the relative policy spread between Australia and peer economies (most notably the US). As such, we would not identify this as a sound buying opportunity in Australia’s currency.
  • In fact, we’d graciously welcome a continued squeeze in the Aussie dollar as a ripe opportunity to short into. Having outlined our bearish bias on Australia’s currency back in JUN ’12 in a note titled, “SLOWDOWN-UNDER” we’ve been purposefully quiet [in print] on Australia since. Indeed, this is one of those rare cases where the [bearish] fundamentals have played out largely according to plan.
  • Moreover, it can be reasonably argued that we’re still in the early-to-middle innings as it relates to the aforementioned bearish fundamental story (which we detail below). Unless you’re of the view that US growth is set to TREND lower from here and that Bernanke/Yellen/Summers/Unknown is likely to roll back tapering expectations or foster outright expectations of incremental easing out of the Federal Reserve (we definitely aren’t), we can’t see why FX market participants would expect the Aussie dollar to sustainably buck its young trend, given how stretched the currency was on both a nominal and REER basis.

THE AUSSIE DOLLAR IS A CROWDED, LIKELY WELL-UNDERSTOOD SHORT

Prior to and likely inclusive of today’s short covering, the Aussie dollar was/is a crowded short. It’s -12.4% depreciation vs. the USD over the past 3M is far and away the steepest decline across DM FX and the most recently reported net short position among non-commercial futures and options contracts (74.2k) was an all-time high for the shorts and -2.4x standard deviations below the trailing 1Y mean.

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 1

Having outlined our bearish bias on Australia’s currency back in JUN ’12 in a note titled, “SLOWDOWN-UNDER” we’ve been purposefully quiet [in print] on Australia since. Indeed, this is one of those rare cases where the fundamentals have played out largely according to plan:

  1. #GrowthSlowing: Raw materials account for 60% of Australian exports and the mining industry accounts for 65.3% of all incremental CapEx in Australia… With the CRB Raw Industrials Materials Index down -12.3% YoY, it’s fairly easy to do the math on why Australian real GDP growth has fallen in a straight line from the cycle peak of +4.4% YoY in 1Q12 to +2.5% YoY in the most recently reported quarter (1Q13).
  2. #MonetaryEasing: Over the past year, the RBA has cut its benchmark cash rate by a cumulative 100bps to a record low of 2.5% – matching the benchmark rate of fellow commodity currency and central banking rival New Zealand (RBNZ) for the first time since APR ’09.
  3. #CommodityRelatedFiscalDeterioration: The latest budget outlook from the Australian Treasury confirms our view that Australian policymakers inappropriately levered their country’s fiscal coffers up to a topping mining CapEx bubble under the leadership of the Labor Party (which may or may not be on its way out; we’ll learn more after elections that must be called by NOV 30). Citing “faster than expected falls in commodity prices”, new Treasury secretary Chris Bowen revised down the country’s 2013-17 revenue estimates by -A$33 billion from forecasts that he inherited from outgoing Treasury secretary Wayne Swan just ~2.5M ago. The most recent budget outlook also calls for the country’s unemployment rate to back up to a 10Y-high of 6.25% by the end of 2Q14… Assuming the [currently] more popular Kevin Rudd captures the premiership in the upcoming election for the Labor Party (in lieu of the more fiscally-hawkish Tony Abbot of the Liberal-National Coalition), we would expect to see Australia’s fiscal position continue to deteriorate over time. International investors own 70% of Australian gov’t debt, so as US Treasury rates continue to back up, they may be less willing to finance the Australian sovereign, at the margins.

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 2

 

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 3

In accordance with the title of this note, we don’t think it’s prudent to run-out and short the Aussie dollar here; in fact, we’d argue that today’s short squeeze is has quite a few more pips to run because it is underpinned by what we’d argue is a moderately hawkish shift in the RBA’s policy bias.

In the process cutting its benchmark cash rate to a record low of 2.5%, the RBA board conspicuously left out a clear path for further easing in its guidance, instead stating that the board “will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time”. It also chimed in with the following statement on the AUD: “It is possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy.”

 

THERE’S LIKELY MORE PAIN TO COME, THOUGH… BUT DON’T JUST TAKE OUR WORD FOR IT

It should be duly noted that the RBA was in a small pool of DM central banks that helped its economy steer clear of recession during the 2008-09 Global Financial Crisis; the fact that they are just now cutting rates to an all-time low TODAY only augments our structurally bearish bias on the Australian economy – which itself continues to be supported by our structurally negative biases on Chinese economic growth and commodity prices (email us if you’d like to get up to speed on either view) – the confluence of which have underpinned marginal improvement in Australia’s current account dynamics over the past 5-10 years.

  

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 4

 

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 5

Moreover, it can be reasonably argued that we’re still in the early-to-middle innings as it relates to points #1-3, as outlined above. Unless you’re of the view that US growth is set to TREND lower from here and that Bernanke/Yellen/Summers/Unknown is likely to roll back tapering expectations or foster outright expectations of incremental easing out of the Federal Reserve (we definitely aren’t), we can’t see why FX market participants would expect the Aussie dollar to sustainably buck its young trend, given how stretched the currency was on both a nominal and REER basis.

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 6

 

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 7

 

IS THIS A “SHORT-COVERING” OR “BUYING” OPPORTUNITY IN THE AUSSIE DOLLAR? - 8

In that light, we’d graciously welcome a continued squeeze in the Aussie dollar as a ripe opportunity to short into. More importantly, we would not identify this as a sound buying opportunity in Australia’s currency – particularly from an intermediate-to-long-term perspective.

Darius Dale

Senior Analyst