Undermined by perceptions of overvaluation and excessive long positioning in the currency, the Aussie dollar has been the one of the worst-performing currencies in recent weeks as the prospect of the Federal Reserve tapering its quantitative easing (QE) programme caused a wave of deleveraging across global markets.
Standing close to $1.04 on May 1, AUDUSD has since plunged almost 10 big figures and is hovering around $0.94.
The currency’s fall was given added impetus on Tuesday by the release of the minutes of the Reserve Bank of Australia’s (RBA) June meeting, which noted the negative impact of Fed tapering expectations on the currency, but also cited domestic factors, including its own monetary policy easing, as well as fears over Chinese growth.
Indeed, the central bank appeared to give the green light to further selling of the Aussie dollar – noting that the currency could decline further, given the decline in Australia’s terms of trade – a development it believes will be helpful to rebalance the country’s economy.
Still, there remains one source of support for the Aussie dollar that might go some way to easing fears over another violent sell-off in the currency: the world’s reserve managers.
The Australian dollar is widely seen as one of the currencies that has attracted demand from reserve managers in recent years.
The IMF has recognized this, announcing it will start to break out reserve manager holdings in the Australian dollar for the first time when it releases its quarterly breakdown of central bank currency holdings later this month.
Its quarterly Cofer data tracks the changing currency composition of reserve manager portfolios. Currently, only holdings in the dollar, euro, yen, sterling and Swiss franc are published separately. Holdings of other currencies are mixed together in what the IMF terms “other currencies”.
The IMF has announced that from June 28 it will publish central bank holdings of the Australian and Canadian dollars, which have long been suspected as making up the majority of the other-currency category.
As can be seen from the chart below, this other-currency component has grown markedly in recent years, standing at just over 6% of allocated reserves, or $372.4 billion. It is important to remember that allocated reserves are only 60% of total reserves – 40% of respondents to the IMF’s survey, including China, the world’s largest currency reserve holder, do not reveal the exact breakdown of their holdings.
It seems reasonable, however, to assume they hold an equivalent proportion of their reserves in this other-currency category.
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Some believe the publication of the breakdown of Australian dollars held by reserve managers will go some way to calming fears over the extent of the potential flight away from Australian assets.
Gareth Berry, strategist at UBS, says given that more than 70% of the Australian Commonwealth bond market is in foreign hands, investors should instinctively be concerned, given the inherent risk of sudden capital flight.
However, he believes the upcoming data release could reduce – but justifiably not eliminate – worries on that front.
“We are likely to discover that reserve managers hold the lion’s share of the Australian bond market,” says Berry.
“Their investment horizons are measured in years, not days. That means the traditional image of a foreign investor who tends to flee at the first sign of trouble does not apply in this case.”
Berry cites the recent experience in Japan, where despite the gyrations in the JGB market, foreigners have not cut and run. That is because, as the chart below shows, at least half of foreign holdings are tucked away on sovereign balance sheets, which has been a source of stability for the yen.
“So the scale of foreign positioning in Australian bonds is not as threatening for the Australian dollar as it first appears – a view next week’s IMF data is likely to encourage,” says Berry.
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Furthermore, some believe that the Australian dollar’s recent slide is not likely to undermine reserve managers’ future demand for the currency.
Steve Barrow, head of FX strategy at Standard Bank, says it is not perceptions over its future trend but other issues that influence reserve manager demand for a currency.
“These include things like the liquidity of the market and, perhaps more importantly, the fact the RBA has not been forced to adopt the same potentially currency-undermining quantitative easing policies of some other major reserve currencies – notably the dollar,” he says.
“In other words, if reserve managers want to scale back on QE currencies, they could look no further than the Aussie.”
That might not stop the Australian dollar from falling in the near term, but once the private sector clear-out of long positions in the currency is over, it should offer the currency some stability.