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Australian investors not awake to currency risk

Simon Derrick  |  10 Apr 2018Text size  Decrease  Increase  |  
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While the Japanese Yen has proven a notable beneficiary of rising trade tensions between the Trump administration and China, the Canadian dollar and more recently, the Australian dollar, have been among the more vulnerable of mainstream currencies.

The logic behind the declines seen in the Canadian dollar is easy enough to understand given that Canada remains the largest exporter of aluminium and steel into the US and the ongoing uncertainty over the North American Free Trade Agreement.

Rather more interesting, however, has been the delayed but decisive response by the Australian dollar. Having spent most of this month quietly strengthening--thanks in part to the promise that Australia would be spared US steel and aluminium tariffs--the Australian dollar recently came under pressure, as investors have considered Australia’s exposure to Asian markets in general and China in particular.

These renewed concerns come at an interesting time for Australia. Over the past two-plus years, the currency has been able to shrug off a sharp decline in yield support against the US dollar across much of the curve, thanks to improving sentiment surrounding Australia’s major trade partners.

In particular, it’s interesting to note that the post-January 2016 recovery in the Australian dollar coincided with the start of a recovery in the Shanghai Composite. Additionally, both seem to have tracked each other reasonably closely since then.

The risk would therefore seem to be that deteriorating sentiment towards China and Chinese markets could leave the currency looking particularly exposed given the lack of yield support.

Indeed, it’s worth highlighting that the 2-year, 5-year and 10-year yield gaps are now at such extremes that US yields actually stand above their Australian equivalents. This situation hasn't occurred since 2000, when the AUD was trading closer to US $0.50. For the moment, it appears that investors have yet to wake up to this risk. While six-month implied volatility in Australian dollar / US dollar has risen since the start of the year, it still remains over 300 basis points below the 10-year moving average.

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Equally, while there has been something of a widening out in 25 delta risk reversals since February, the premium being paid for puts still looks extremely muted when compared to that seen through much of the past decade. Even the data from the Commodity Futures Trading Commission, showing positioning in the futures markets, indicates that speculative players are essentially flat the Australian dollar.

This lack of apparent concern is interesting when it’s remembered that the Australian dollar, much like the British pound, has shown a marked propensity over the past 18 years for rapid and sustained moves.

As just one measure, it’s worth noting that more than 20 per cent of year-on-year moves have developed for the Australian dollar against the US dollar since the start of the new century.

For the moment, the two year-plus uptrend remains intact. However, should it break, then the risk is that a particularly sharp move develops.

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Simon Derrick is chief currency strategist, BNY Mellon. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is BNY Mellon's chief currency strategist.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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