Much has been made of the fact that the strength in AUD has been driven by sovereign demand for Australian debt, but it is the foreign direct investment (FDI) sparked by the country’s mining boom that has been the real driver of the currency, argues ANZ.
That, the bank believes, should make for a much more stable AUD than has been the case.
The focus on sovereign demand for Australian government bonds was intensified by comments from Guy Debelle, assistant governor of the Reserve Bank of Australia, who said earlier this year that as a consequence of the debt problems in Europe, sizeable flows were occurring into Australian government debt.
Australia is not alone, with many believing that diversification from the world’s reserve managers into the narrowing group of AAA-rated countries is also putting upward pressure on the likes of NOK, SEK and CAD.
However, Richard Yetsenga, head of global markets research at ANZ, says it is record Australian FDI inflows that have been responsible for the strength of the AUD. Indeed, those flows have been responsible for sending Australia’s basic balance – FDI plus the current account balance – into positive territory for the first time since the 1970s.
“Of late, the analytical focus for the AUD has been on portfolio flows, particularly bond flows,” he says.
“The Australian balance-of-payments data suggest, however, that the AUD’s strength has little to do with a boom in portfolio flows, and everything to do with a mining boom, which has encouraged a flood of FDI.”
Record FDI drives Australian basic balance into surplus
Source: Bloomberg, ANZ
Yetsenga says this has created a different environment for the AUD, since typically low-yield, current account surplus currencies – NOK, CHF and at one point JPY – run basic balance surpluses.
“For a commodity exporter to do so is almost unheard of,” he says.
Yetsenga concedes there has been strong inflow into Australian government bonds, but that they have been partially offset by outflows from bank bonds, as well as equities.
Australian bond inflows
Source: Bloomberg, ANZ
The change in the nature of the AUD has some evident implications for the currency.
It should mean that the AUD will be less responsive to swings in risk appetite and monetary-policy expectations. That is because the FDI inflows that are funding the country’s current account deficit are the result of investment decisions in the mining sector, not the newsflow that typically drives day to day moves in financial markets.
That implies the AUD will trade more like a safe-haven currency, even though it is a commodity exporter.
Yetsenga believes the AUD should therefore trade with lower volatility and a more neutral volatility skew than is normal historically.
“This means that currency moves will tend to be less rapid, and rallies will tend to occur with almost the same vigour as sell-offs,” he says. “The ‘up by the escalator and down by the elevator’ mnemonic is no longer appropriate.”
The theory suggests that AUD is unlikely to weaken against the USD until the mining investment pipeline turns sharply lower. According to ANZ, that will not happen until mid to late 2013.