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MAY 17, 2004
How Scary Is The Aussie Dollar's Dive? The markets often view it as a herald of global trends -- but don't panic yet The financial markets have always viewed the Australian currency as a harbinger of global economic trends. After all, Australia is a major exporter of iron ore, coal, and other commodities, demand for which is an indicator of economic vitality. When the Australian dollar rallied against other major currencies over the past year, it closely tracked rising commodities prices. But after hitting seven-year highs against the greenback in February, the Aussie buck has plummeted to five-month lows. Ominously, the last time it took such a dive was in 2000 -- when the tech and Internet bust in the U.S. started a global economic slump. The time before that was during the severe recession of the early 1990s. Is it time for investors to take cover? Market players aren't quite ready for pell-mell retreat. Analysts say that while the currency is unlikely to rebound to its Feb. 18 high, when the Australian dollar bought 80 cents. Neither will it plummet to the low of 47 cents it hit in early 2001. The reason has as much to do with U.S. interest rates and Australian economic growth as it does with global commodities prices. "Fundamentally, the Aussie dollar remains very firm," says Paul Xiradis, director of equities at Sydney-based investment-management company Ausbil Dexia Ltd. He expects it to stabilize near its current value of about 73 cents. During 2003, however, you could have tracked the overheated growth of China from a dollar-trading house in Sydney as well as from the docks of Shanghai. China's insatiable appetite for raw materials helped push up global commodities prices to 10-year highs. The Aussie dollar climbed 33%, then surged 6% more in the first two months of this year before reversing course as commodities prices softened. Commodities make up 57% of Australian exports. And China alone consumes 30% of Australia's iron-ore exports. Another factor driving up the Australian dollar has been the gaping spread between U.S. and Australian interest rates. Booming consumption and borrowing, especially in the red-hot real estate market, has led the Reserve Bank of Australia to keep rates high when they were at record lows in the U.S. "The Australian interest-rate cycle is almost 180 degrees from where the U.S. cycle is right now," says David de Garis, senior treasury economist at Australia & New Zealand Banking Group in Melbourne. Savvy investors, including many hedge funds, rode the rally to the limit, borrowing money cheaply in the U.S. and plowing it into higher-yielding Australian bonds -- a form of arbitrage known as a carry trade. "It has all been hot money streaming in," says David Hale, chairman of Chicago-based consultancy Hale Advisors LLC. "The currency is a casino chip." HEADY DAYS ARE OVER. But in late April, People's Bank of China Deputy Governor Wu Xiaoling blew the froth off Australia's bubbling currency by urging Chinese banks to curtail loans to rapidly expanding steelmakers and other consumers of raw materials. At the same time, the U.S. Federal Reserve began sending signals that its benchmark interest rate of 1% would not last the year. With speculators guessing that the gap between U.S. and Australian rates will narrow, the fund flow is starting to reverse. "The heady days for the carry trade are behind us," says Richard Franulovich, senior currency strategist at Westpac Bank (WBK ) in New York. But while diminished, such trading won't disappear overnight. After all, 10-year U.S. bonds yield only 4.5%, compared with 5.9% on similar bonds in Australia. The 1% U.S. benchmark interest rate isn't expected to rise any higher than 3% by the end of the year. Of course, if China can't prevent a hard landing, then commodities prices could get hit. And the Fed may have to hike rates if inflation surges in the U.S. In either case, that would push the Aussie dollar down and send the currency investors packing.  By Chester Dawson in New York, with Patrick Gray in Melbourne Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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