Trouble down under ? The Aussie in focus ......

Trouble down under ? The Aussie in focus ......

ref :- SHORT VIEW by Jennifer Hughes, The Financial Times, Companies and Markets

We're staying with foreign exchange markets today, but heading a long way south. Anyone not actively involved in currency trading and based squarely in the Northern hemisphere might fail to see why the fortunes of the Australian Dollar might have any relevance to their existence. They might also be surprised to learn that according to TX Capital,  AUD/USD was the 4th most traded currency pair in 2016 (after EUR/USD), USD/JPY and GBP/USD) and accounts for over 5% of total volumes. That, given the enormous size of the global FX market, is a whole heap of change. But beyond mere volume, the Aussie Dollar is a proxy for commodity prices, and acts as a barometer of the well-being of the Chinese economy. That makes it relevant for us all, and something worth keeping an eye on.

At a time when President-elect Trump is teaching us all a new way of doing things on an almost daily basis (is this really how it's going to be ?), we shouldn't be too surprised at anything. But you can't help but be slightly nonplussed by the news that Aussie Prime Minister Malcolm Turnbull's contact with the newly-elected Mr Trump had to be brokered by ex-golfer Greg Norman (well, it was news to us at any rate and our thanks to Ms Hughes). Now Mr Norman was a very great player and is a highly successful businessman, but is not necessarily anyone's idea of an official channel. Nevertheless, even if Mr Trump doesn't seem to worry too much about upsetting other world leaders, Mr Turnbull would have been very keen to have a word with him about his intentions towards China. Any sign of a US - China trade war breaking out would be very bad news for Australia and point to a considerably weaker currency.

Historically, as befits a nation so dependent on commodity prices, the Aussie dollar is a pretty volatile unit but that was not the case in 2016. In fact, its 9 cent trading range against the US dollar was the narrowest for ten years and about half the average annual range. Since the US election, the Aussie has weakened by about 2%  --  which makes it one of the better performers amongst the majors. Whilst narrowing interest rate differentials (US rates expected to rise, of course) and trade war risk act against it, higher commodity prices have been supportive. The question is, will the relative calm continue ?

Judging from the tone of Ms Hughes piece, that's unlikely. At the very least, one can expect a sharp increase in volatility and closer examination of the fundamentals does not bode well for the Aussie. Yes, higher commodity prices have been supportive and have engineered Australia's first monthly trade surplus in over two years  --  but that was a function of higher prices that may very well not be sustained rather than increases in the volume of trade. Not many think we're about to see any kind of surge in demand.

And the downsides may not yet have been factored in. Regarding interest rate differentials, the Reserve Bank of Australia is expected to sit on its hands for the foreseeable future whilst the US Federal Reserve is expecting to raise rates three times in 2017 alone. Aussie 5-year government bond yields are just 20 basis points higher than their US equivalents, the smallest yield premium since 2000. And that trade war risk ? If Donald Trump has been less than forthcoming on some elements of his intended economic policies, he has barely missed an opportunity to rattle sabres in China's direction. To put into perpective just how much of a problem this might turn out to be for Australia, consider this : China is BY FAR Australia's largest trading partner, in value terms taking 30% of its exports. That's about the same amount as its four next largest partners  --  Japan, South Korea, India and the US  --  combined.

So of the three supportive pillars for the Aussie  --  higher interest rates, Chinese growth and strong commodity prices  --  the first barely applies any longer and the second is under severe threat from Trump's trade rhetoric. The third ? If Chinese growth is under threat, it's hard to make a case for healthy prices in industrial commodities. Time for a re-think ?