Australia’s currency has risen sharply in recent days.
- The Australian dollar passed through 68 US cents today, up 24 per cent from its mid-March low
- The Reserve Bank kept interest rates on hold at a record low 0.25 per cent but they are higher than US, British, EU and Japanese rates
- Australia has posted another current account surplus, based on a large trade surplus as iron ore export prices boom above $US100/tonne
From its lowest level in nearly two decades of 55.1 US cents in mid-March, this morning it was worth 68.13.
That means in less than 10 weeks it has jumped 24 per cent in value against the US dollar even while the world’s economies endure the sharpest global downturn since the Great Depression, Australia’s included.
You may be assuming it’s because of the dire political-economic situation in the United States at the moment pushing the greenback lower.
But currency analysts say it has far more to do with the fact that China’s economy has been waking from its COVID-19 coma, so its insatiable hunger for Australia’s mineral resources (particularly iron ore) has returned.
Iron ore price boom
Iron ore prices have been on a tear recently.
They have surged to $US102 a tonne, due to increased demand from China and severe supply disruptions in Brazil (one of the world’s major iron ore suppliers).
Even with the recent rise in the Australian dollar, iron ore prices in local currency terms are very close to their all-time highs.
WA’s iron ore mines may save Australia
Western Australia’s decision to keep its iron ore mines running during the COVID-19 pandemic may have helped save Australia’s economy from a much worse decline.
Iron ore is Australia’s main export it accounted for over 16 per cent of exports in 2018-19 so when iron ore prices surge, the demand for Australian dollars often increases strongly.
Chinese economic activity began to pick up noticeably in March and April after a dismal January.
“The rebound in Chinese activity, being a very industrial-focused economy, is certainly helpful for demand for iron ore,” Westpac currency strategist Sean Callow tells the ABC.
“There’s been quite a decent recovery in industrial production, while retail spending has been very negative.
“It’s hard to force people to leave their homes and spend money, but it’s very easy to crank up state-owned factories to improve industrial production.”
In April, Chinese industrial production increased by 3.9 per cent year-over-year, while retail sales contracted by 7.5 per cent.
Confidence in the global economy
Strangely, analysts say the dollar has also been strengthening because investors have become more optimistic.
Optimism is relative, and the mood in recent months has been very dark, so any sign of improved economic conditions can be cause for optimism.
Don’t count on a quick coronavirus recovery
As efforts to control COVID-19 appear to be gaining traction, many analysts and traders are hoping for a quick return to business as usual. They’re likely to be disappointed, writes Ian Verrender.
Cotton futures and sugar futures made strong gains on Monday, and oil prices have been recovering from their recent lows.
Commonwealth Bank analyst Tobin Gorey says the US dollar weakened against most agricultural exporters’ currencies on Monday and most big agri-exporters are also dominant energy and/or hard-commodity exporters.
“The COVID-19 pandemic likely still has a few twists and turns that will call that optimism into question,” Gorey explains.
“Uncertainty, though, should not be conflated with downside only. The current pandemic is a ‘first’ for literally everyone.
“So we don’t have any experience of what a reopening recovery looks like.”
Intrepid Aussies trapped at home
The fact that Australians can’t travel overseas at the moment is another reason why the dollar has been strengthening.
Even though we generally think of Australia as a major tourist destination, in some years Australians spend more abroad than foreigners spend here.
Australians are not allowed to travel overseas at the moment.(ABC News: Brendan Esposito)
Last year, in part because of a weaker currency, Australia ran a travel surplus foreign travellers spent $11 billion more here than we spent overseas.
Even so, Australians still took $52 billion overseas last year to spend in other jurisdictions.
Since we can’t travel, none of that money is being spent it’s trapped in Australia’s economy to circulate here.
Moreover, with Australia being one of the most successful countries so far at containing coronavirus, it only cements the nation’s status as a safe and desirable destination to visit once foreigners are again allowed to.
Record trade surpluses
The surge in commodity prices has seen Australia’s trade position post extremely rare numbers.
For the first time since at least the 1970s, Australia has recorded 12 consecutive months of current account surpluses meaning it has been generating more income from its exports and overseas investments than it has been spending on imports and paying out to foreign investors.
In the first quarter of this year, the current account surplus widened to a record $8.4 billion (around 1.7 per cent of GDP).
“There aren’t many risk-sensitive currencies that are backed by current account surpluses,” Mr Callow observes.
“It’s very unusual for the Australian dollar to have this type of situation it’s the first time we’ve seen anything like this since the mid-1970s.
“It means the Aussie’s not as likely to be hit by the vicissitudes of investor sentiment, it’s not as fragile.”
Banana republic surplus?
Australia recorded its biggest current account surplus in the September quarter and the first one since 1975, but it was mainly on the back of a short-term jump in iron ore prices.
But Dr Sarah Hunter, chief economist for BIS Oxford Economics, argues the medium-term outlook for services exports is still very challenging, given the continued ban on arrivals from overseas.
“The closing of the border to arrivals from China in February, followed by the near-suspension of international travel in mid-March, led to a 12.8 per cent fall in exports and a 13.6 per cent drop in imports [in the March quarter],” she notes.
“Looking ahead, the data suggests that imports will be more impacted than exports over the near term; the transition to online, remote learning for universities will provide some support to earnings from education, which will partially offset the decline in revenue from international tourists.”
High interest rates relatively
The Reserve Bank board met today to discuss the state of Australia’s economy.
It left interest rates at 0.25 per cent, as expected.
While that is a record low for Australia, it’s relatively high for the developed world. Britain’s central bank benchmark is at 0.1 per cent, the US Fed is targeting a range of 0-0.25 per cent, and key interest rates remain below zero in the EU and Japan.
The Reserve Bank cuts interest rates to a record low and announces a quantitative easing program for the first time in its history to help prevent a coronavirus-driven recession.
Moreover, unlike the Reserve Bank of New Zealand, Australia’s RBA has publicly stated its extreme reluctance to consider moving to negative interest rates.
After today’s meeting, the RBA governor also sounded a slightly optimistic note.
“The Australian economy is going through a very difficult period and is experiencing the biggest economic contraction since the 1930s,” governor Philip Lowe noted.
“In April, total hours worked declined by an unprecedented 9 per cent and more than 600,000 people lost their jobs, with many more people working zero hours.
“Notwithstanding these developments, it is possible that the depth of the downturn will be less than earlier expected.
“The rate of new infections has declined significantly and some restrictions have been eased earlier than was previously thought. And there are signs that hours worked stabilised in May, after the earlier very sharp decline.”
That hint of positivity comes before tomorrow’s important release of March-quarter GDP figures.
Most analysts think Australia’s economy contracted by 0.4 per cent in the March quarter, due to the summer’s catastrophic bushfires and lockdowns.
With a massive contraction baked in for the current June quarter, that would put Australia in its first technical recession two consecutive quarters of economic contraction since “the recession we had to have” 29 years ago.
However, as with interest rates, it appears that Australia will emerge from COVID-19 in a less bad position than many other nations, making the local currency relatively attractive.
Where will the dollar go from here?
This year has been one of the most damaging and volatile years in decades, and we’re only half-way through it.
There’s much more news to come, with lots of potential negative shocks the simmering US-China trade war, the domestic political situation in the United States and the threat of second-wave outbreaks of COVID-19 in Australia and elsewhere.
Economy won’t look the same post COVID-19
The “road out” of coronavirus may head in an entirely different direction to the one we travelled towards the chasm and the bridge to cross it may need to be much longer than many now imagine, warns Ian Verrender.
Mr Callow says Westpac’s analysts think the Australian dollar will be sitting around US68c at the end of the year, but that assumption comes with lots of caveats.
“The recovery in the dollar does seem a bit too strong from our point of view,” he warns.
“Why did it rise 2 US cents yesterday? It seems like there’s been a bit of overshooting.
“But it indicates the sentiment was probably very negative on the Aussie, and maybe a lot of bears have thrown in the towel.”