Why the Australian dollar is going to get weaker

[Editor’s note: This column was written by Sovereign Man Chief Investment Strategist Tim Staermose]

Earlier in the year I published a piece, setting out why I thought a weaker Australian dollar was inevitable.

In light of the recent bounce in the Australian dollar, some people have asked me about it.

My views have not really changed.

I am a long-term thinker on this. Yes, the recent bounce in the Australian dollar versus the Greenback has been both a large one, and a surprising one. It has risen from 87c to 94c over the course of the past 10 weeks.

But, I don’t think anything has fundamentally changed to alter the longer-term downtrend in the Australian dollar, which had become very expensive, at over US$1.05 last year.

The latest bounce in the Aussie, yesterday, came on the back of surprisingly strong Australian employment numbers for March.

The market chose to seize on the headline number, a net addition of 18,100 jobs, which saw the unemployment rate dip 0.2 percentage points to 5.8% in seasonally adjusted terms.

The conclusion from the market was that interest rate cuts in Australia are thus unlikely in the near term, and rates may even go up. And, for foreign investors fleeing zero interest rates at home and parking money in Australia, that was deemed a good thing.

Unfortunately, I think it’s erroneous thinking.

If anyone bothers to read the fine print, the latest Aussie employment numbers were actually not very healthy at all. Lots of full-time jobs were lost, and lots of part-time jobs were created.

From the government press release:

“Seasonally adjusted part-time employment increased in March 2014, up 40,200 persons to 3,524,000 persons, while full-time employment decreased by 22,100 persons to 8,029,100 persons. The increase in total employment resulted from:
• an increase in female part-time employment, up 32,000 persons
• an increase in male part-time employment, up 8,300 persons
• a decrease in male full-time employment, down 8,700 persons
• a decrease in female full-time employment, down 13,400 persons.”

This is hardly something to crow about. A large increase in female part-time employment is more likely a sign of distress in the economy than a signal of strength.

Like in the US, the labor force participation rate has also been declining steadily in Australia as some people simply give up looking for work.

I don’t think anyone on the Reserve Bank of Australia’s interest rate policy setting committee would be in a hurry to raise interest rates based on the “strength” of these statistics.

Meanwhile, the FX market seemed to completely ignore the very weak Chinese trade data that also came out this week. Both imports and exports fell in March, versus the same month in 2013. Exports dropped 6.6% year on year and imports fell a more a hefty 11.3%.

What’s more, market commentators can no longer hide behind the old chestnut that “the data were distorted due to the Lunar New Year holidays.” Both March 2013, and March 2014 were “clean” months for China, data wise, with no holiday timing issues.

Some have argued the numbers are still distorted, because last year’s figures were artificially high, due to padded invoices, as Chinese firms sought to overstate their foreign exchange earnings, in order to bring more money back into the country. Maybe so, but that just means all the backslapping about last year’s high, healthy trade numbers was misguided.

Whatever the case, China’s economy is clearly slowing. And that’s ultimately negative for the Australian economy and the Australian dollar.

To give you another crucial “catch all” indicator, the World Steel Association sees steel demand growth this year in China slowing to just +3%, and in 2015 they expect further growth of just +2.7%.

This contrasts with double-digit growth rates in recent years. And, while this is likely a good thing for China longer-term, as it means they are building less empty apartment towers and fewer bridges to nowhere, it’s NOT GOOD for the Australian commodities producers who extrapolated double-digit growth in Chinese demand indefinitely into the future.

And that’s a big longer-term negative for the Australian dollar, in my view.

The Aussie dollar’s downward adjustment to a more reasonable valuation on a purchasing power parity basis may be taking a little longer than I expected. But, I think the adjustment is still underway to an ultimately lower AUD/USD exchange rate.

About the Author

Tim Staermose is Sovereign Man's Chief Investment officer, based in the Asia-Pacific region. Born to a Danish father and British mother in Dar Es Salaam, Tanzania, Tim has led an international life since the day he was born. He has lived and worked throughout Asia, primarily focusing on equity research and emerging market opportunities.