The Australian dollar has put in a strong performance during the US debt-ceiling crisis as investors have shunned the US currency.
That has seen it extend a rebound that began in September, which has also been supported by suggestions from the RBA that it has finished its monetary easing cycle, alongside signs of stabilization in the Chinese economy, Australia’s largest export market.
Neil Mellor, currency strategist at BNY Mellon, the world’s largest custodian bank with $26 trillion under management, says the spat in the US Congress over the debt ceiling exacerbated a process that was set in motion a long time ago.
“There has been a growing disillusionment with the dollar among reserve managers that has prompted a quest for alternatives en route to a longer-term goal of ending dollar reserve accumulation altogether,” he says.
“We have therefore suggested that the Australian dollar, along with a range of other currencies, must be considered a natural target for reserve managers.”
Certainly concerns have been growing in China, the world’s largest FX reserve holder and the biggest foreign holder of US Treasury bonds, worth $1.28 trillion, according to US government data.
China’s Xinhua news agency said this month it is “perhaps a good time for the befuddled world to start considering building a de-Americanized world” and that the wrangling over the US debt ceiling had left “many nations’ tremendous dollar assets in jeopardy and the international community highly agonized”.
BNY Mellon’s iFlow data show that fund managers abandoned the dollar after the minutes of the Federal Reserve’s June meeting were published on July 10. Those showed the central bank backtracking on the idea floated by Ben Bernanke, Fed chairman, in May that it would start to taper its quantitative-easing programme.
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Indeed, the minutes stated that: “Many members indicated that further improvement in the outlook for the labour market would be required before it would be appropriate to slow the pace of asset purchases.” Since July 10, BNY Mellon’s iFlow data show that fund managers have been putting funds into what the bank dubs “alternative reserve currencies”, namely the Australian dollar, Canadian dollar, sterling, yen, Norwegian krone and New Zealand dollar.
For the Australian dollar, those flows – along with improved economic data from China and the abandonment of the RBA’s dovish stance in the face of record Australian house prices – have seen it rise by 5% against the dollar since hitting lows below $0.90 in early September. That came after a sharp decline in the second quarter that saw it fall by more than 10% from highs above $1.05.
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That slump in the value of the Australian dollar was encouraged by the RBA, which even after the 10% fall by early July said further losses were likely, while a month later – with the currency’s collapse worth 15% – it cut rates to 2.5% and said the Aussie might fall further.
The recent rebound in the Australian dollar is, therefore, unlikely to be welcomed at the Australian central bank, which is trying to shift its economy’s reliance from resource intensive growth.
Indeed, as Mellor points out, the RBA has persistently cited a weaker currency as something it would like to see, having declared the Australian dollar to be about 15% overvalued in February. It would, therefore, regard the currency’s fall since then as an insufficient correction.
Furthermore, Mellor notes that with positioning data from the Commodity Futures Trading Commission suggesting that short-term speculators have plenty of room to wind up short positions in the currency, the RBA might well be conscious of the potential for an “export crunching” move back towards parity in AUDUSD at a time when its economy can ill afford it.
“A further rise in an already overvalued currency may yet pose serious problems for the Australian economy’s tentative rebound,” says Mellor.
That, in itself, might not be a strong reason to expect intervention from the RBA. However, the fact that Washington has been a driving force behind the recent weakening of the US dollar could reignite the currency war debate.
“If we add the fact that currency appreciation is arising partly as a result of self interest in Washington – inadvertently rekindling notions of currency wars – then the bank might consider it justified to fight fire with fire, at least on a provisional basis,” says Mellor.
FX investors might be wise to be ready for a re-emergence of currency war hostilities from the guardians of the world’s alternative reserve currencies.