“Pacific Peso” AUD Under Pressure

Last night the Aussie dollar hit lows not seen since the very beginning of last year and at the time of writing was sitting at just 73.48c.  That represents a 7% drop from the 80.41c we saw in January this year and is why gold is still up 2% this year in AUD terms compared to being down 4% in the US.  The big question now of course is where to next?

There has been a bit of press this last week with some big names pretty bearish on our AUD.  Locally, QIC have shorted it and ANZ also came out yesterday with a bearish view citing a weak domestic picture and increasing global uncertainty exacerbated by the trade wars.  

We wrote last week of the yield trade pressure with the US rates at 2%, and expected to rise, but the Aussie rate’s stuck at 1.5% for some time yet.  The other key dynamic is the faltering Chinese market and the Aussie being the proxy play on that.

Many forget that China is a communist country that strictly controls the international flow of its Renminbi (Yuan).  That has 2 key impacts on Australia.  First, the recent tighter crackdown on outflows means the Aussie property market (particularly apartments) is seeing the biggest buyer group evaporate putting pressure not just on new sales but also settlement of existing sales as the Chinese find it increasingly hard to get their money out to buy or settle on our property.  That ANZ report commented:

“In addition, uncertainties around the housing market and what a deceleration in prices may mean for wealth and spending are adding to downside risks for the AUD.”

The second impact is that the AUD or affectionately/disparagingly known as the “Pacific Peso” is often considered a proxy for the Chinese Renminbi/Yuan given it is freely traded whilst the latter’s restrictions make it difficult to trade.  Why this is playing out against the AUD right now is that China is experiencing some very concerning financial issues.  This year their sharemarket is down over 20%, officially into a bear market, they are devaluing the Yuan and pumping liquidity into the market.  Remember too that China has the biggest debt pile in the world.  The Wall Street Journal had this to say:

“China’s currency is down nearly 1% from Friday’s close, wiping out the yuan’s gains for the year, after the People’s Bank of China cut reserve requirements for banks over the weekend. Slowing growth and rising trade tensions are pummeling Chinese shares, with the Shanghai Composite entering a bear market Tuesday. And rising defaults are testing the country’s gargantuan debt market.

To investors with a long memory, this may sound uncomfortably familiar. The last big yuan selloff, beginning in mid-2015, was heralded by a historic stock-market collapse, a rash of corporate bond defaults and Chinese monetary easing.

As in 2015, the U.S. and Chinese central banks are moving in opposite directions, making yuan assets less attractive. Investors owning Chinese rather than U.S. 10-year government bonds pocketed a measly 0.6 percentage-point yield premium in May, the smallest since late 2016.

China is now gradually easing monetary policy, while the Federal Reserve is tightening. Trade tensions are rising, and China posted its first current-account deficit since 2001 in the first quarter. Growth will probably slow further in the second half.

Panic or no panic, a weaker Chinese currency in the months ahead still seems likely.”

The other pressure this introduces for China is that aforementioned debt pile is largely tied to the USD.  Much of China’s debt is USD denominated and China, you will recall, is the largest holder of US Treasuries in the world (outside of the US Fed), some $1.2 trillion worth.  A rising USD against falling RMB make that harder and harder to repay.

We mentioned the other day the adage ‘if the US sneezes, Australia catches the cold’ in reference to the US Sharemarket.  However if China sneezes Australia is likely to get full on pneumonia. 

For gold and silver holders that could see the double tailwind of financial markets flight to safety and a falling AUD increasing the domestic spot price.