Recently, the
Australian dollar (AUD) regained its stature as one of the top performing
currencies against the U.S. dollar. Trading near a 3-month high, the Aussie
traded firmly above .9100 USD per AUD, far above July's low of 0.8300. It is up
over 12 percent against the USD over the past 12 months. In comparison, the GBP
and EUR are down almost 8 percent in the same time period. The reason is simple:
there is demand for this higher-yielding currency. For now, the AUD is
benefiting as: riskier assets are in vogue after most of the European banks were
given passing marks after the recent EU stress test; domestic growth is
outpacing most of the industrialized countries; and higher Australian interest
rates are in the forecast.
Strong Growth
Australian
consumer confidence surged in July, the most in 13 months, as employers continue
to add jobs. With Chinese demand for natural resources, the Australian mining
industry is booming and is pulling down unemployment. The June unemployment rate
was 5.1 percent, the best number in a year. A recent Melbourne Institute survey
of consumer sentiment jumped 11.1 percent. The Reserve Bank of Australia held
borrowing costs unchanged for the past two months after raising them six times
between October and May to help curb price pressures as the economy expands. The
quarterly inflation rate almost doubled in the first three months of 2010. The
core inflation rate rose 2.7 percent in the second quarter, slightly less than
expectations, but near the upper end of the government target inflation rate of
2 to 3 percent. In addition, the Australian export prices rose 16.1 percent in
the second quarter from Q1. Australian home prices have risen in 19 of the last
20 months.
The concern is that surging economic growth may stoke higher
inflation, forcing the Reserve Bank of Australia (RBA) to continue to raise
interest rates. Future rate increases will depend on key domestic consumer price
figures for the remainder of the year. I expect the RBA to continue to tighten,
lifting rates to 5.0 percent by year-end. The 6-month AUD LIBOR rates are now at
5.124 percent, far higher than the USD .677 percent and the EUR at 1.11 percent.
A strong currency sentiment is also helped by the premium offered by Australian
AAA-rated government 2-year bonds, yielding nearly 4.6 percent over
similar-dated U.S. debt, which is yielding only .6 percent.
The Reserve
Bank of Australia recently said that Australia has "been spared the worst impact
of serious economic recession in terms of jobs lost much as we will be spared
the prospect of higher taxes that face so many in the developed world." Newly
appointed Treasurer Swan projected a higher-than-expected $3.1 billion AUD ($2.7
billion) surplus in three years on surging tax revenue from its expanding mining
industry. The economy will expand 3 percent in 2010-11, less than the 3.25
percent forecast in May, Swan said. The government is also forecasting to raise
an additional 6 billion AUD in resource company taxes because of higher
commodity prices. The spot price of iron ore delivered to Asian nations jumped
last week by the most in almost seven months.
Taxes
In late
June, Julia Gillard was sworn in as Australia's first female prime minister in a
surprise leadership vote, ousting Kevin Rudd. The change in leadership was
followed by the biggest jump in consumer confidence in 13 months. Since her
election, Gillard has struck a deal with the country's largest mining firms —
BHP Billiton Ltd., Rio Tinto Group and Xstrata Plc — to water down a proposed
mining tax rate on coal and iron ore earnings. The proposed tax rate was dropped
to 30 percent from 40 percent. In addition, the government exempted most
commodities and raised the taxable threshold. The government will also cut the
corporate tax rate from 30 percent to 29 percent and to 28 percent by mid-2014,
and will refund state-based royalties currently imposed on mining projects.
However, government officials reiterated that the mining tax will still
contribute over $10.5 billion AUD in the two years from July 1, 2012 to fund
roads, rail and ports, tax cuts for small businesses and government
contributions to pension savings for low-income
workers.
Conclusion
The fundamentals look good for the
Australian economy: national debt is low compared to most other industrialized
nations, employment is high and exports are strong. In addition, China has made
it clear that it does not plan to slow growth, which is supporting demand for
commodities. The concern, however, is that such growth may ignite inflation. The
RBA has already proven they will move on inflation as needed. I expect interest
rates will continue to move higher in the coming months, deepening the return of
the carry trade. In a carry trade, investors borrow a currency in which interest
rates are low (like the USD) in order to buy the higher-yielding AUD. Adding all
factors together, one can only conclude the AUD will remain a top performer.
There is a real possibility we could see the AUD return to the .94 level before
year end.
The views expressed in this column are solely
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