One thing seems quite sure to us as we see things right now; 2013 will be the year to sell JPY.
This is an opportunity we will address in future highlights, but with so many red flags screaming out that Japan is arguably in a vulnerable position both financially and structurally, this should result in the JPY being used as the world’s preferred funding currency.
What is not so certain to us is how the AUD/USD will trade throughout 2013.
WHAT DO THE STRATEGISTS SAY?
Consensus of the 47 currency strategists surveyed by Bloomberg suggests that AUD/USD will average 1.01 next year. The range of opinions is varied, however, with 0.82 the low-ball estimate, while some expect a re-test of the all-time high at 1.10. We could certainly make a compelling case for price appreciation or depreciation from a fundamental perspective, though at what level the currency closes out next year is anyone’s guess and forecasters will no doubt change their call time and time again. What seems clear to us is that while the pair has traded in a range of 1.0147 to 1.0627 since August and three-month option volatility is the lowest since 2007, this could very well be the calm before the storm.
As you can also see from the multi-year weekly chart a clear triangle pattern has emerged, which shows low conviction to push prices around. While we don’t know the direction it will break, given the historically low levels of volatility and the fact that the 21-, 55-, 100- and 200-day moving averages have the tightest convergence in around a decade, when the pair goes, we feel it will really go – the question is in which direction?
INFLUENCE FROM THE US
Firstly, the path the pair takes will be dominated by Fed policy and of course the fiscal cliff and debt ceiling debate (mark two) in February/March. As Fed Chairman Ben Bernanke said in his recent address to the New York Economic Club, the fiscal cliff poses a ‘substantial threat’ to economic recovery, however if a plan is carved out then the new year could be a ‘very good one for the American economy’. Great stuff, now let’s say Congress do cobble a longer-term plan together with modest (1%-1.5%) fiscal drag and we do see 3% growth (which is optimistic, but in line with Fed President Charles Evans’ recent comments), will this see the market bid up the USD on the prospects of the Fed reigning in on its loose monetary policy?
There is a high possibility that they would change their projections from a calendar model to one based around their perception of future economic performance in 2013, and a continued recovery could see the market question whether the Fed will keep its funds rate low till 2015. We don’t think this dynamic will take hold at this stage and still believe a recovery in the US will have a greater benefit to the AUD. However, there will be a psychological tipping point when the USD will react positively to US data, rather than negative news flow, but it’s just not yet.
OTHER KEY FACTORS
China will obviously play a crucial role, but as things stand most expect growth of around 8% on average next year, so barring any major surprises China should keep the AUD bid against a number of the G10 crosses. There is a valid view that by China shifting its economic model to a more consumption-led one, it will consume fewer raw materials as its exports fall, but this is perhaps a story for 2014. Either way, this should be seen as AUD-negative at the margin.
A clear threat to the local unit is the increasingly reported cost over-runs and lack of competiveness in the local economy. Many feel we are facing a fiscal cliff of our own and as the terms of trade fall, so will capital expenditure as companies’ margins get squeezed. We also feel the prospect of US exporting shale gas to Asia has the potential to really impact Australia’s LNG space longer-term. Even if the US energy exporters don’t get a licence from President Obama, the prospect of the US being self-sufficient and potentially the biggest global oil producer longer term should significantly improve its trade deficit, thus in turn strengthening the USD. Many question how low interest rates will be if we really see a decline in our terms of trade and a renewed fall in capex. The theory behind lower rates is obviously to spur on the non-mining space to help pick up the slack; however with housing seemingly having turned a corner, what will 2.25% interest rates do to the housing market bubble?
WHAT LIES AHEAD
The biggest risk to the AUD in 2013, and more so 2014, is potential changes to Australia’s AAA-status. The AUD has been widely supported throughout 2012 as central banks bought Australian government bonds to diversify holdings on the back of the ever-diminishing pool of AAA-rated securities. So for us, the key risk would be a sovereign ratings downgrade and thus a huge reversal of the central bank holdings and subsequently unadulterated AUD selling. We feel this is a low possibility, however if the mining story gets out of hand, watch the AUD as traders question how low the AUD could go on the prospect of a downgrade.
On a brighter note, if the mining space doesn’t show too many cracks, Greece gets extra time to get its budget in order, Spain requests the ECB’s OMT program, the US grows around consensus and money managers allocate a higher percentage of their portfolio’s towards equities (currently at record lows), then perhaps AUD/USD can do very nicely indeed. This in turn would cause the RBA to become much more active than they have been in 2012 to curb the AUD’s strength, notably through off-market activity.
2013 promises to be very interesting and potentially more volatile.