Currency Corner
Australia’s macroeconomic picture is also darkening somewhat and so adding weight to our thesis that the pair is materially out of sync. In the early part of 2013, Australia posted its widest trade deficit in nearly five years — generally an ominous sign and precursor of currency weakness. The deficit for November widened to $2.6 billion from $2.4 billion in October and that was the biggest monthly shortfall since March 2008. With the devastating wild fires they have sadly experienced too, there is a real expectation for further softening in the economy this quarter. Australian retail sales also unexpectedly fell in November adding to evidence that an economic slowdown in China last year was hurting more than just the country’s mining industry. Among the indicators of an increasing so called “output gap” (a measure of slack in the economy) are the rising numbers of jobless and the National Australia Bank’s own measure of capacity utilisation. The NAB monthly business survey shows the amount of spare production capacity has been rising since 2010, and increased sharply in the latter half of 2012. The November survey had overall capacity utilisation down to 79.5 per cent, its weakest level since mid-2009 and down from 81 per cent at the beginning of the year. With greater idle capacity comes more intense competition and greater reluctance to push prices higher — a factor that will likely result in the reserve bank cutting interest rates by at least another 0.5% this year. NAB’s chief economist believes construction is well below its long-term average, particularly the sub-sector of house building which is at its weakest level since the period immediately following the introduction of the GST in July 2000. With manufacturing operating at only 74.3 per cent of capacity too it is abundantly clear that the last thing the Australian economy now needs is a strong currency.
It is a heavily export driven one, particularly given it’s commodity exports to Asia and one of the stabilisers of a weak economy is a depreciating currency — something reserve bank officials have openly stated that they welcome. Back to the UK. Given the fact that the market’s expectation that the UK’s AAA sovereign rating is almost certain to be lost this year has been well flagged, then it is arguable that this event “is now in the price” — similar to when the US was stripped of its rating last year — bonds and the dollar subsequently rose after this event. Should the UK actually escape a downgrade, then the pound is likely to strengthen on a pure relief basis. Take a look at the chart below and we can see a very long “saucer” formation has been in the making now for nearly three years. The pair has shown a marked reluctance to remain beneath the $1.50 level for anything other than a very brief period. Having returned to $1.51 at the time of writing, we think this is an ideal time to get long on a risk:reward basis, taking into account the fundamental and technical factors that lean unarguably to the bull side. Should the BoE pull back on their dovish noises and/ or the UK surprise to the upside with the next GDP figures, and in contrast the Australian reserve bank reduce interest rates again, this is likely to be the catalyst that pushes the pair on a trajectory path back towards the $1.80-$1.90 level. Please note that given the interest rate differentials between the two countries, that shorting the Aussie dollar actually costs you each day and so one must expect the pair to move by greater than the interest rate differential – 2.5% which would require, on an annual basis, a move above $1.56 — a level we expect to be taken out and some this year.
80 | www.financial-spread-betting.com | February 2013