Caught in a dollar daze

While the “special demand” that has been holding up the Australian dollar may be diminishing, National Australia Bank’s global co-head of foreign exchange strategy, Ray Attrill, sees only a moderate decline in the value of the currency over the next year or so.

By “special demand”, Attrill means demand created by central banks that have been pouring money into the Australian dollar and government bonds in recent years.

Foreign demand for Australian bonds and currency has remained strong right up until the second quarter of this year, when it began to taper off, a trend Attrill says is likely to continue.

Foreign investors bought far fewer Australian commonwealth government bonds in the June quarter ($5.6 billion) than the average of the previous three quarters ($19 billion per quarter).

Attrill’s best guess is that foreign central bank reserve allocations to the Australian dollar have begun to decline too (this figure is not measured separately but currency strategies have a fair idea).

Foreign investors have been buying the Australian currency and Australian assets to diversify away from the US dollar and because of the perceived safety of Australian assets.

The build-up of foreign money has been unprecedented, with offshore investors now owning 80 per cent of the government and corporate bond markets.

To get at those bonds, investors must first buy Australian dollars and they have been unwilling to hedge away that exposure for the same reason they’re buying the bonds in the first place – Australia’s “haven” status.

This buying has created the “special demand” Attrill points to that he says has had many watchers of the currency scratching their heads.

“We’ve always been told to think the Australian dollar is tied to the fortunes of commodity prices and interest rate differentials [on which basis] surely the Australian dollar should be trading lower than it currently is,” he says.

However, with this foreign buying having gone as far as it realistically can, Attrill says the Australian dollar should begin to trade more in line with fundamentals.

However, Attrill is not expecting a swing to historic levels – the average rate since the currency was floated in 1983 has been about US75¢ and, as many remember, the currency was trading at US65¢ as recently as 2009.

Attrill’s prediction is for the currency to remain at parity through this year and be trading about US97¢ at the end of 2013.

Attrill’s prediction may not seem bold but it may be if it is considered that, when currency valuations change, their tendency is to swing more violently than incrementally.

“Expecting a graceful move in one direction is contrary to historical expectations,” he comments.

Only time will tell if the Australian dollar is mature enough to step down gracefully from its current platform.

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