Monday 24th February 2020
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A decade-long slide in Australian interest rates is threatening to turn one of the global currency market’s most popular wagers on its head.
Investors with an appetite for a little risk had a winner for years with a carry trade that saw them borrow trillions of yen at near-zero rates and use the money to buy Australian dollars. Holding onto the Aussie for as little as a few weeks could earn them enough interest to make the trade pay. Those brave enough to stick with it for months or more made huge profits. Not anymore.
Foreign exchange traders are starting to look Down Under as a place to source cheap funds, not somewhere to invest them. It’s quite a snub for a nation in its 29th year of economic expansion, and comes as policy makers struggle to counter the financial impact of drought, wildfires and the coronavirus.
“If you’d told me five years ago that the Aussie would become a nice funding currency, I’d have been laughing at the absurdity of the idea,” said Shaun Roache, chief Asia-Pacific economist at S&P Global Ratings in Singapore. “It’s a remarkable shift in mindset for markets.”
It’s a far cry from the heyday of the currency in 2011, when much of the developed world was still clawing its way back from the global financial crisis. Australia had skirted recession, the local dollar was worth more than its U.S. namesake and the central bank’s benchmark rate was a healthy 4.75%.
It’s now a record-low 0.75%, and tipped to go lower.
While loans in yen and euros are still going for a steal, strategists have identified potential carry trades by borrowing the Aussie and selling it to buy a host of currencies, ranging from the Mexican peso to the Indonesian rupiah.
The Australian dollar has climbed the rankings of funding currencies to be one of the most efficient to pair against the peso, according to Adam Cole, Royal Bank of Canada’s currency strategy chief for Europe.
It’s becoming a “low yielding risky asset,” much as Canada’s dollar was for many years, Cole said in a report last month.
Wages are barely rising, household debt is sky-high and companies are reluctant to invest. And few other countries find themselves as dependent on China, where economic growth was easing even before the trade war with the U.S. and the outbreak of a deadly virus.
A decade ago, China’s rampant demand for Australian commodities exports propped it up while other nations faltered. Today the relationship looms as a huge risk.
The dislocation caused by the coronavirus has halted production lines across China, putting Australian exports in jeopardy. Fears of contagion have also brought flights from China to a standstill, and with them a massive inflow of tourists and students that support the services sector.
None of this has gone unnoticed by the Reserve Bank of Australia, whose interest-rate policy provides a cornerstone of the carry trade.
Underscoring the difficulties facing the economy, the RBA late last year began publicly discussing the possibility of rates eventually dropping all the way to 0.25%.
This could then force it into an asset purchase program known as quantitative easing -- a path followed by Japan and Europe -- and something once regarded as unthinkable in Australia.
While the central bank’s tone has moderated over the past few months, investors who sell the Aussie now to buy other currencies face little risk of rates Down Under rising and hurting returns when they close out their trades.
Money markets are currently pricing in one cut by the RBA to 0.5% by August this year.
“The Australian dollar faces significant headwinds by virtue of being a low carry currency,” said Francesca Fornasari, a portfolio manager and head of currency solutions at Insight Investment in London.
But not all strategists think the Australian dollar is the way to go for low-cost funding.
The euro and the yen remain the “classic” plays to sell in carry trades, even if the Australian dollar can be paired well with the likes of the rupiah, said Ranko Berich, head of market analysis at Monex Europe Ltd. in London.
Deutsche Bank AG’s Tim Baker agrees. “I don’t think the world is so desperate for funding currencies that Australia’s becomes one,” said Baker, a macro strategist for the bank in Sydney.
Yet the Aussie does have another thing that bolsters the case for using it in the new carry trade -- it is becoming less prone than the yen and euro to being bounced around by volatility in the stock market.
For investors who have to weigh the chances of movements in the currencies and interest rates of two countries, one less thing to worry about has value.
“I think it will be used more and more as a funding currency,” S&P’s Roache said of the Aussie. “The idea has only started to spread.”
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