Is China's Decision Going To Hurt Canada and Australia?

China’s surprise decision to raise interest rates on October 19th rattled global markets. Two of the biggest immediate losers were the Canadian (CAD) and Australian dollars (AUD).

The question now is whether China’s move will hurt the currencies in the longer term. Let’s take a look.

China raised its one-year lending and deposit rate by 0.25%. The move is intended to calm skyrocketing consumer prices – currently riding way higher than benchmark targets. It’s the country’s first rate increase since December 2007.

The last time this happened, investors feared a slowdown as Chinese manufacturers found it harder to get cash. Less production would mean less demand for raw materials. Less demand for raw materials would mean a commodity correction.

Of course, the Canadian and Australian economies depend on their commodity exports. Canada is mainly known for its oil, natural gas and timber reserves. Australia exports coal, iron ore and gold to its largest export partner – China. China’s last rate cut in 2007 led the Australian and Canadian dollars to sell off – by an average of 3% in the following month.

But it proved to be an overreaction. Both currencies quickly regained lost ground in the following month.

I believe the same thing is happening again – we’ve seen a short-term pullback, but the long-term trend is up. The fundamentals continue to remain attractive in both currencies

Consider the depth of their trade relationships. Of course, Canada maintains strong trade with other major powers like the United States, Mexico and the United Kingdom. And although China is Australia’s largest export partner – dominating about 22% of the market – it still maintains great trade relations with other booming Asian economies. One such economy, India, is expected to expand by 8% in the next 6-12 months, which means no slowdown in its demand for raw materials.

So, if one trade partner falls out of the picture, both Canada and Australia are set to recover on stable demand from its other resource-hungry partners.

And that’s not all. Both countries survived the global recession and now enjoy a strong domestic consumer presence.

Australia is in the middle of a record mining boom, and its gross domestic product growth is expected to climb by an average of 3.5% over the next two years. Canada is expected to expand by an average of 3% over the same time period. Both eclipse the growth rates expected in the United States.

Meanwhile, spending is rising steadily in both countries. Australia’s retail sales figures have risen for five consecutive months, and Canada’s retailers continue to run full percentage points higher than US counterparts. This growth fuels further development in the Canadian economy, especially in construction and industrial sectors, which has enjoyed a housing boom over the last two years.

So, with recent data being nothing short of impressive for both Australia and Canada, prospects are good for the two commodity-dependant economies. Economic growth is on the rise and domestic spending is strong. And central banks in both Australia and Canada are expected to continue their recent spate of rate hikes in the near future. The demand for higher yield will lead investors to funnel their money into Australian and Canadian investments, supporting strong currencies against the US dollar.

So expect the Australian and Canadian dollars’ weakness to be only temporary. Yes, China still matters. But given the underlying fundamental strength and diversification of their global trade relationships, it’s clear both major currencies will still be preferred against the US dollar in the long run. With prices only starting to rebound, investors could consider the Canadian and Australian dollars a buying opportunity in the short term.

Richard Lee
for The Daily Reckoning