Will the Australian dollar follow its usual pattern of recovery as global sharemarkets recover?
Few questions are more important for institutional investors, or international equity funds with unhedged currency exposure.
Fund managers nominated the Australian dollar as the second-most important consideration in portfolio construction over the next 12 months, second only to Chinese economic growth, in Russell Investment's latest quarterly survey of investment managers.
The Australian dollar has been strongly correlated with global equity markets in recent years; when the sharemarket corrects, so too does our currency and vice versa.
As AMP Capital chief economist Shane Oliver notes, 70 per cent of Australia's exports are commodity-related, so any news that threatens global economic growth, and thus commodity prices, weighs on the Australian dollar.
Also, during times of uncertainty, investors unwind positions in higher-yielding currencies such as the Australian dollar, and the US dollar usually gains. "The Australian dollar will likely rebound again once sharemarkets bottom," Oliver said this week. "The latest plunge is nothing new."
The consensus view supports Oliver's forecast. Newswire AAP this week said that of the 13 currency experts it surveyed, eight expected the Australian dollar to be trading above parity with the US dollar by year's end, and only one forecast it to be below US90 cents.
Certainly, the Australian dollar's latest falls, from US$1.08 in February to US98 cents this month, are in line with 13 per cent and 14 per cent corrections, in 2010 and 2011 respectively, as global sharemarkets tumbled.
Although notoriously hard to predict, the Australian dollar might be due for an extended period of consolidation around current levels, even if global sharemarkets recover some recent losses.
Russell Investment's survey found investment managers remained relatively bearish towards the Australian dollar and thought it was significantly overvalued at levels above parity with the US dollar - a view shared by many companies groaning from an elevated currency.
Several investment banks this month revised their currency forecasts because of a weaker view of Chinese economic growth, the escalation of Greece's sovereign debt crisis and potential for it to leave the European Union, and ongoing global risk aversion.
UBS now expects the Australian dollar to trade at US97 cents against the US dollar in three months, compared with a previous forecast of US$1.
The prominent European economist Steen Jakobsen this week described the Australian dollar as "drastically overpriced" and forecast it to fall to US90 cents, then US80 cents, according an AAP report. Jakobsen is the global chief economist of Denmark's Saxo Bank.
Westpac chief economist Bill Evans said in the bank's May 2012 Market Insights report: "We believe that the weight of probabilities favour the imminent weakness that we expect in the Australian dollar to extend beyond the middle of 2012 and into the September quarter."
Westpac forecast the Australian dollar to trade at US98 cents at the end of the third quarter, before a strong fourth-quarter recovery to US$1.04.
So much depends on the outlook for China and commodity prices, global risk appetite, and the strength of the domestic economy and likelihood of further interest rate cuts this year.
On balance, the odds still favour a stronger Australian dollar later this year as China shows more signs it will avert a so-called economic hard landing. Another possible round of quantitative easing in the US in the third quarter would most likely boost the Australian dollar.
Even so, the correlation between our dollar and global sharemarkets might become less clear-cut this year in such a volatile market.
Holding international equities, with unhedged currency exposure, could be a more attractive strategy if the relationship between the Australian dollar and global sharemarkets weakens.
Tony Featherstone is a former editor of BRW and Shares magazines.
