The Australian dollar

Once a Darling, Australian Dollar Loses Favor

WSJ,

15 October, 2012

China's economic slowdown is creating a new hierarchy in the currency market.

The Australian dollar, once sought after because of the country's big iron-ore and coal exports to China, is falling out of favor with some investors. Instead, they are turning to the Canadian and New Zealand dollars, two currencies they say still stand to benefit from steady demand for their commodity exports even as China slows.

It is a marked change from the trend of the past few years, when investors had flocked to the Australian dollar, lured by its strong economy and high interest rates. Since then, China's slowdown has hit Australia, prompting the Reserve Bank of Australia this month to lower rates for the third time this year.

"In the past, the Australian dollar was the commodity currency of choice because it had everything going for it: high interest rates, robust Chinese growth and a solid Australian economy," said Nick Bennenbroek, head of currency strategy for Wells Fargo WFC -0.50% in New York. "Those things that were positive are not so apparent anymore."

Since early August, as a drumbeat of negative economic news came out of China, the New Zealand dollar, known as the kiwi, has risen 1.4% against the U.S. dollar, while the Canadian dollar, called the loonie, is up 2.3%. Meanwhile, the Australian dollar, or the Aussie, has fallen. The Aussie was trading at $1.0254 late Monday in New York, down from over $1.06 in August. Bets by traders on the Canadian dollar are more than double those of the Australian dollar in the futures market, in which that dynamic was reversed in early August, according to regulatory data.

Paul Chappell, who manages $360 million as chief investment officer of U.K.-based currency fund C-View, is among those buying the kiwi and selling the Aussie, partly because New Zealand's economy relies less on exports to China than Australia's. A Chinese economic slowdown means less demand for Australia's exports, which reduces capital inflows, hurting the Aussie.

China takes 27% of Australia's exports but only 14% of New Zealand's, according to government data.

New Zealand's biggest export is dairy products, in which Japan and the U.S. are top customers, along with China. Prices for dairy products are down 4% since the start of the year. Iron-ore prices are off 18% over the same period. "New Zealand's diversified number of trading partners puts the kiwi in a less vulnerable position than a lot of other currencies," Mr. Chappell said.

Like New Zealand, Canada's top export is a commodity, oil, in which China isn't the biggest customer. Oil prices are down 7.1% on the New York Mercantile Exchange this year.

To be sure, Canada and New Zealand aren't immune if China's slowdown is an early sign of a global retrenchment. Last week, the International Monetary Fund cut its 2013 global growth forecast to 3.6%, down 0.3 percentage point from its July outlook. And trading volumes in the kiwi are smaller than in the U.S. and Australian dollars, meaning it could be harder for investors to get out if the market turns.

"If New Zealand growth does weaken, you'll have a currency that looks overvalued, and then the illiquidity and small size of the market will become an issue," said Alan Ruskin, global head of G-10 foreign-exchange strategy at Deutsche Bank DBK.XE +5.06% in New York.

Jeffrey Sica, who oversees about $1 billion in assets as president of Morristown, N.J.-based Sica Wealth Management, started buying Australian dollars about a month ago. Mr. Sica said that even after the central bank's rate cut in October, Australia still offers attractive rates compared with other developed countries, noting that he sees a small likelihood for more rate cuts. "It's clear that Australia is not embracing currency devaluation in response to what's going on with China because they are more concerned with inflation," Mr. Sica said. He said while China is slowing down, it is still expanding substantially compared with the rest of the world.

Lower interest rates in Australia mean investors have less incentive to return to the Aussie. Some investors have bought the Australian dollar as part of a "carry" trade, in which they borrow a currency where rates are low and exchange it where rates are high. However, the Reserve Bank of Australia's benchmark rate of 3.25% is down from 4.75% a year ago. New Zealand's central bank has kept rates steady at 2.5% over the same period, while some economists expect the Bank of Canada to raise rates from their current 1%.

Wojtek Zarzycki, who manages Optimal Investing, a $150 million private investment firm, is selling Australian dollars and buying the loonie. Mr. Zarzycki expects the Australian dollar to fall against the Canadian dollar; the two currencies are roughly equal today, but he sees the Aussie buying only 92 Canadian cents within the next year.

"Canada is a good proxy" for the U.S. economy, which is picking up speed, while the Aussie mimics China's diminished prospects, Mr. Zarzycki said.