SBM’s currency trade for 2013 – short australian dollar v sterling

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The Aussie dollar has been a hot ticket for yield hunters for nearly 4 years now, being shored up by central banks looking to diversify their foreign exchange reserves and whom have piled into the currency, aswell as large amounts of speculative money in recent years. To us, the sustainability of the Aussie’s gains is now reaching the end and we expect this pair to be a major outperformer (in sterling terms) through 2013.

With the real supports of Australia’s triple-A credit rating, high interest rates relative to most other Western nations and its resource-rich economy, the Aussie dollar has put on almost 10 per cent since the start of June against the US dollar but has largely been forming a base against sterling as the chart below shows. It is widely accepted that PPP for the GBPAUD pair is anywhere between $1.95-$2.20 and with the downtrend in this pair now into its 5th year and the technicals pointing higher, there is a strong argument were at ground floor of a re-rating in the pair and likely to move back towards this range this year.

Australia’s macroeconomic picture is also darkening somewhat adding weight to our thesis. This week it posted its widest trade deficit in nearly five years – generally an ominous sign and precursor of currency weakness. The deficit for November widened to $2.6 billion from $2.4 billion in October. That was the biggest monthly shortfall since March 2008 and was wider than analysts’ expectations for a deficit of $2.3 billion. With the devastating wild fires they are now sadly experiencing too, then there is a real expectation for further softening in the economy this quarter quite aside from the waning exports to contend with. Australian retail sales also unexpectedly fell in November adding to evidence that an economic slowdown in China last year was hurting more than just the country’s mining industry…

The amalgamation of these economic factors is leading to speculation that the Reserve Bank of Australia may slash interest rates again after cutting them by 25 basis points to 3 per cent in December to boost the flagging economy. Make no mistake, if this view becomes more cemented then given the very real risks to the domestic banking system from further weakness in the already shaky housing market there, the Aussie’s yield advantage will continue to diminish – precisely at the time that loose monetary poilicy exits are being considered in the US. The Pound generally follows the dollar, and although our economy still remains weak, and so exit strategies are behind the US, if the US dollar moves ahead v the Aussie, the Pound will be dragged along in its wake.

Given the markets expectation that the UK’s AAA sovereign rating is to be lost this year has been well flagged, then it is arguable that this event “is now in the price” – similar to when the US was stripped of its rating last year – bonds and the dollar subsequently rose. Should the UK escape the downgrade then the Pound is likely to strengthen on a relief basis.

Ian Stannard, European head of FX strategy at Morgan Stanley in London made the following comments recently – ”Australia’s real yield advantage has eroded, reducing [the Australian dollar’s] attractiveness as an investment currency.” According to Daragh Maher, senior currency strategist at HSBC, more traditional reserve currencies could make a comeback, including the euro as the risk of a euro-zone breakup diminishes. He sees the Aussie dollar ending the year at $0.95 against the US dollar, compared with the $1.0528 it was trading at against the US dollar overnight. 

We are heavily long the Pound v the Aussie and expect rich rewards out of this during 2013 aswell as it being a good hedge for weakness in the overall market given its negative correlation with the equity markets and our long portfolio in mining plays.

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