The rising Australian dollar has more investment managers reviewing hedging strategies, but few are punting on a sharply lower currency.
The main forces boosting the Australian dollar have strengthened in recent weeks. Fund managers who bet our currency was overvalued against the greenback and reduced portfolio currency hedging earlier this year are hurting.
They may hurt a little more yet. Stronger Chinese manufacturing data this month supports higher commodity prices and a firmer Australian dollar. The greenback is under more pressure as economists shave US growth forecasts, and as monetary authorities there print more money to reflate the struggling US economy.
The Reserve Bank of Australia’s (RBA) surprise 25 basis-point interest rate hike in November and the prospect of at least a couple more rises in the next 12 months also support a higher currency.
Add to that improving risk appetite as Australia deals with a “large expansionary shock” as RBA governor Glenn Stevens puts it, and it is hard to see the Australian dollar retreating.
These positive fundamentals have prompted economists, such as AMP Capital Investors’ Shane Oliver, to predict our dollar will easily break parity with the greenback and stay around US$1.10.
Oliver is not alone in thinking the Australian dollar will keep rallying.
There is a view in some quarters that the US dollar needs to fall more to reflect that country’s muted growth prospects, trillion-dollar deficit, and the risks that quantitative easing will further erode the greenback’s value.
However, economists who believe our dollar is destined to stay above US$1 for some time are in the minority.
The consensus view of 24 economists polled in The Australian Financial Review’s quarterly economics survey in late September was for a currency at 93 US cents in three months, and 92 US cents in six months.
Investment managers I spoke to in the past few weeks also expect the Australian dollar to retreat from currency levels close to parity.
BT Investment Management global macro strategist Joe Bracken is one of them. Bracken expects the Australian dollar to settle between 85 US cents and 95 US cents.
Other investment managers privately told me they have been lowering portfolio currency hedging to take advantage of an expected easing the Australian dollar.
The risk of the currency rising sharply from current levels is low enough to remove more hedging, but few investment managers are making drastic hedging changes or rushing to buy offshore assets.
As always, it is a question of timing. I also think our currency is slightly overvalued, but would not be betting against the market at this stage.
Things could be very different in a year or two. There’s no doubt an Australian dollar above parity for an extended period will damage sectors outside of resources.
More analyst profit downgrades, especially for industrial companies with significant offshore operations, filtered through last month, suggesting earnings expectations are too high.
The aggregate performance of the top industrial companies will deteriorate if the Australian dollar keeps rising. Resource companies will be less affected, with the rising Australian dollar usually accompanied by higher commodity prices.
Macquarie Group research, for example, highlights the strong correlation between local resource stocks and the Australian dollar.
In theory, Australia’s consistently lower productivity growth and higher inflation rates than its global peers should be driving the currency lower. Lower productivity, higher inflation, higher interest rates, a higher exchange rate, and a resource sector crowding out other parts of the economy is an awful combination for most industrial companies, should it last.
Add to that more Australians using their stronger relative purchasing power to buy offshore goods, and the medium-term outlook suggests the Australian dollar should be well below current levels.
