That could result in further losses for AUDUSD, which is down over 13% since the start of the year and over 8% weaker since late May when the Federal Reserve first floated the idea that it might begin to taper its quantitative easing programme.
Indeed, AUDUSD is threatening to dip down below the three-year low of $0.90 that it hit earlier this month as the weakness in Asian emerging market currencies accelerates.
The link between the Aussie and Asian currencies is relatively straightforward. Some 76% of Australia’s exports go directly to the region and thus swings in Asian currencies tend to have a large impact on the Australian dollar.
Richard Grace, chief currency strategist at Commonwealth Bank of Australia, says his favoured GDP-weighted non-Japan Asian currency basket currently sits at a one-year low, thanks largely to declines in the Indian rupee, Indonesian rupiah and the renminbi.
“At times AUDUSD will act as a proxy for Asian currencies because the liquidity in the Australian dollar is larger than the combined liquidity of the 10 major non-Japan Asian currencies contained in the basket,” he says.
| Australian dollar and non-Japan Asia currencies versus US dollar |
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| Source: CBA |
The drop in emerging market Asian currencies has been led by the Indonesian rupiah and the Indian rupee amid fears over the countries’ widening current account deficits.
Both Indonesia and India have moved from having current account surpluses to current account deficits in the past few years. Recent developments have taken both countries’ current account deficits to levels as large, as a percentage of GDP, as they were during the Asian financial crisis of 1997-98.
| Indonesia and India current account balances - % of GDP |
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| Source: CBA |
The Indonesian rupiah fell to a four-year low against the dollar on news that the country’s current account deficit widened again in the second quarter, thanks to slower commodity exports.
That, combined with figures showing rising inflation and slowing growth in Indonesia, has raised fears over the country’s economy. That in turn has weighed on the rupiah, especially since the level of foreign ownership of Indonesian bonds, at 30%, is one of the highest in Asia and raises the prospect of a potential acceleration of capital outflows that might put further pressure on the currency.
The Indian rupee, meanwhile, has dropped to a record low against the dollar, thanks to a widening current account deficit, widening government budget deficit, slowing growth and persistent inflation pressures. Indeed, India’s GDP growth has more than halved from 2010 levels to an annual rate of 4.8% at the end of the first quarter of this year.
Although the Reserve Bank of India has implemented liquidity measures to try to fight weakness in the rupee, the currency has continued to depreciate.
The bottom line is that while the US-led rise in global yields has led to a steepening of the yield curve in both Indonesia and India, it has only complicated the policy choices for the authorities in both countries and done nothing to slow the downward pressure on the rupiah or the rupee.
Indeed, many expect further losses for both currencies against the dollar.
As mentioned earlier, that could lead to further losses for AUDUSD given Australia’s export exposure to Asia and given the Australian dollar’s role as a proxy for Asian currencies because of its liquidity advantage.
Indeed, a full-blown Asian financial crisis akin to that of 1997-98 will have the potential to drag the Australian dollar down sharply.
Maurice Pomery, chief executive at research firm Strategic Alpha, believes $0.90 is an important pivot point for AUDUSD and the Aussie dollar looks set to shift to a new lower trading range.
He says it seems global investors are finally waking up to the fact that rising US, and other developed world, yields will impact emerging markets heavily, especially those running current account deficits.
“I am not sure investors will be that fussy as I think some big real-money accounts will exit the EM space altogether rather than keeping risk on based on some hope the domino effect doesn’t hit them, “ he says.
“There is a real danger in the emerging markets here and the spill-over will hit many asset classes across the globe.”
Grace, however, has a more sanguine view.
He believes that although developments in Indonesia and India will weigh on the Australian dollar, it is important to note that those two economies remain the exception to aggregate regional current account surpluses across Asia.
“Hence we don’t expect a pattern of contagion to develop as it did in the 1997-98 Asia crisis,” he says.
“Rather, it is more likely that rallies in the Australian dollar will continue to be sold into for a period of time.”
As well as external pressures, the Australian dollar also faces pressures from the monetary stance of the Reserve Bank of Australia.
The minutes of its August meeting revealed that the RBA has not abandoned its easing bias, as was originally perceived by the market following the publication of its monetary policy statement on August 6.
The minutes left the market in no doubt as to the RBA’s real monetary policy stance, saying that “the inflation outlook might afford some scope to ease policy further, should that be necessary to support demand. The forecasts for this meeting suggested no lessening of that scope”.
Grace believes the RBA is likely to sit on the sidelines until November in order to assess third-quarter inflation data due in October and any upward pressure on Australia’s unemployment rate.
“There remains a large risk of further interest rate cuts by the RBA over the next 12 months,” he says.
Hence a central bank that has reiterated its easing bias combined with continued worries over Asian currencies could prove to be a toxic mix for the Australian dollar. It is one that could well see AUDUSD trading below $0.90 for some time.