Australian Dollar a Top Choice for Currency Investors

The dollar kept within the fairly tight range it has established over the past few weeks. The dollar index has remained between 81 and 82 for the past 15 days, after jumping higher on the Greek financial crisis. Currency traders are uncertain of where the global economy is heading, and seem to be taking a ‘wait and see’ approach. Eventually a clear picture will start to emerge, but for now, the currency markets are stuck in a rut.

The weekly jobs data released yesterday morning didn’t give investors much to go on. The numbers came in slightly higher than expected, surprising many who thought the improvement we saw in the monthly numbers at the end of last week would carry over to the weekly report. But it still looks like any improvement in the labor picture here in the US will be slow to come, and pretty sporadic. The Labor Department blamed the Easter holiday for skewing the numbers, saying the two weeks around the Holiday weekend are traditionally volatile making it difficult to discern an underlying trend. But the less volatile four-week moving average of claims, a less volatile measure, also increased to 450,250 last week from 448,000.

No matter what spin the Labor Department puts on the data, the numbers show that the labor picture isn’t getting better. It may not be getting worse, but it is still not getting any better. And Bernanke and his buddies at the Fed are not going to look to raise rates until we see a significant improvement in the labor picture. With rates staying low for an ‘extended period’, investors will continue to look to diversify into higher yielding currencies. The global economic rebound is going to be uneven, with China and India leading the western world out of recession. Commodity-based economies that supply these countries with much needed raw materials will benefit, and their currencies should appreciate.

One such economy can be found down under in Australia. I was asked by Frank to put together a couple paragraphs on why the Aussie dollar (AUD) is a good currency choice for investors. Never one to waste effort (and seeing that I need a bit of Pfennig filler this morning) I thought I would share them with the readers this morning.

The Australian dollar continues to be a top choice for currency investors. Several factors have combined to make the Aussie dollar the best performing major currency over the past 12 months, with an increase of over 30% versus the US dollar. First, Australia has a commodity-based, export-driven economy with a strong central bank. Australia is entering their 19th consecutive year of economic growth, after avoiding the global downturn of the past two years. Their close trading ties to China have allowed them to weather the global crisis much better than their G10 brethren. The strong and steady growth in China has kept commodity prices climbing, supporting the raw material exports of Australia and underpinning their currency. Growth in the Australian economy rose in the fourth quarter at the fastest pace in two years as GDP climbed 0.9% from the third quarter and 2.7% year over year. The economy is expected to grow 3.25% this year and then 3.5% in the following two years, good sustainable growth rates in an uncertain global climate.

The biggest jobs boom in more than three years and a surge in business confidence is further evidence that the economy is already growing at or close to trend. Employers added 194,600 jobs in the five months through January and sent the unemployment rate to an 11-month low of 5.3%, which is close to half that in the US. While the February employment numbers came in less than expected, it nonetheless was a positive figure and marked the 5th straight month of gains. Economists are expecting steady declines in the jobless rate to 4.7% by year-end and many see wage pressure intensifying once it falls below 5%.

The strong economy has allowed the Reserve Bank of Australia to begin increasing interest rates, making their currency even more attractive for investors. The RBA was the first G10 central bank to raise rates, and has increased rates 5 times in the past 6 central bank meetings. The latest move occurred earlier this week, and in the statement accompanying the rate announcement, central bank Governor Glenn Stevens indicated that rates would continue to rise. Governor Glenn Stevens said the move was a ‘further step’ toward returning interest rates to average levels. He is trying to cool a housing market that continues to look as if it is in danger of overheating. “Interest rates to most borrowers nonetheless have been somewhat lower than average,” the governor said in today’s statement. “With growth likely to be around trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average.”

These interest rate increases have pushed up the yield differential between Australia and the US and Japan. High interest differentials encourage ‘carry trade’ investments, where investors borrow at the low rates available in Japan or the US and invest the proceeds into the higher yielding currency of Australia. Carry trades pushed the Australian dollar to double-digit returns versus the US dollar in 2007 and 2009 and should continue to encourage investment flows into the Aussie dollar throughout 2010.

Confidence in the global economic recovery was boosted by data released in Europe yesterday morning. German exports rose the most in eight months and producer prices in the UK rose faster than predicted. The recent fall in the value of the euro (EUR) helped push exports up 5.1% in February compared to January when they fell 6.5%. German companies are stepping up production to meet global demand. Manufacturing growth accelerated in March and business confidence increased. Still, the Greek crisis has cast a large cloud over the Eurozone, and will probably keep the euro-area economy growth at a moderate pace.

The Bank of England kept rates unchanged and kept its bond purchase program (quantitative easing) in place. They held the target for its asset-buying plan at 200 billion pounds, as everyone predicted. The BOE didn’t comment on the economy or the outlook for policy due to the upcoming elections. The two candidates continue to debate the best policy direction for the UK, and how aggressive they need to be on reigning in the deficits. I read an article in yesterday’s UK Telegraph which discussed the drastic measures that need to occur in the UK. The challenger, David Cameron, and his Conservative party have been pushing for major cuts to public spending; and got some backing from the Bank for International Settlements yesterday. The BIS said that Britain would need ‘drastic’ austerity measures to prevent public debt exploding out of control. Interest payments on the UK’s public debt will double from 5% of GDP to 10% within a decade under the BIS base scenario before spiraling upwards to 27% by 2040. This is by far the highest among the OECD club of developed countries; even worse than either Greece or Italy.

And leaders shouldn’t look to ‘grow out’ of their debt problem. The OECD recently cut its UK growth forecast for the UK, predicting rather tepid growth of just 0.5% during the first quarter of 2010. Readers know my opinion about the pound sterling (GBP); I wouldn’t touch it. And the UK economy has many striking similarities to our own, so the future of the US dollar isn’t all that bright either.

Chris Gaffney
for The Daily Reckoning