A$ Moving to Parity?

Tuesday, October 12 2010

As you have probably noticed the A$ has been moving towards parity. The key drivers of this move are as follows

  1. The Australian terms of trade is extremely strong due to the strength of commodity prices.
  2. Australian interest rates are expected to increase relative to the rest of the world.
  3. Expectations that quantitative easing in the US will drive down the value of US currency. In addition other countries and regions are also competing to lower their currencies (Japan and Europe) to ensure their economies remain competitive.

We think the third reason is the most important from the currency perspective.  We think that the currency is more than fair value at current levels but that momentum and quantitative easing means it is hard to be confident about the US$ at present. A pick up in US growth is the key factor which would change this momentum.

Quantitative easing is designed to drive reflation. The Federal Reserve is seeking to stimulate economic activity to drive stronger nominal GDP growth of 5%, the majority of which likely comes from inflation. Inflation is the classic coin shaving technique of government since the Roman Empire. In modern parlance, you print money faster than required, and look for the private sector to spend it to generate investment and consumption, and then deal with the consequences in a later decade. If the private sector “through undue caution“ refuses to spend then GDP growth will not take hold.

Pleasingly the most recent data highlights the banks willingness to lend which is important to drive the liquidity into the broader market.  While consumer demand has remained soft it seems to have bottomed. The key driver from our perspective is corporate confidence and a pick up in corporate spending. Corporates continue to sit on a large amount of cash and the deployment of this cash will be a critical driver for the global economy.

 

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