Many happy returns
Hong Kong investors who took a punt on the Australian dollar earned high rates of return last year - and although the ride may be choppy, there is more to come, say currency watchers.
The Reserve Bank of Australia (RBA) raised interest rates to 7 per cent last month, the third increase in six months. This means that the Hong Kong dollar deposit converted into Australian dollars 12 months ago would have delivered a 16 per cent conversion gain before taking into account interest rate differentials. And, with Australian interest rates headed higher as Hong Kong rates head lower, the case for keeping investments in Australian dollar assets in the first half of the new year remains compelling, according to analysts.
Minutes of RBA's last board meeting on February 5 were released on February 19 and revealed that board members had contemplated a larger 50-basis-point increase in cash rates in their campaign to throw the brakes on inflation, before settling on a 25-basis-point increase to 7 per cent.
Read together with job data that showed a fall in Australia's unemployment rate to a new 33-year low of 4.1 per cent in January, the case for at least one, and possibly two, further rate increases from the RBA, is now judged a near-certainty by the market.
In the view of HSBC chief economist for Australia and New Zealand, John Edwards, the Australian dollar may be bid up from its February levels of about 91 US cents to 95 US cents by the middle of the year.
Mr Edwards says driving these gains will be a widening 'carry' between Australian interest rates that are likely to reach 7.5 per cent as United States rates track below 2 per cent.
Investors who borrowed in lower-yielding currencies to invest in the higher-yielding Australian dollar - a 'carry trade' - have earned a substantial return on fixed interest, or term Australian dollar deposits, last year, Mr Edwards says, and this will continue to be an attractive proposition through most of this year. 'Basically, because we are growing so quickly; because we have not shared in the kind of mortgage market difficulty that has afflicted the US; and we have a rising inflation rate.'
Mr Edwards says he expects the RBA to increase the cash rate by 25 basis points this month and once again before the middle of the year.
For investors, the upshot of a rising differential between Australian dollar rates and US-linked rates is that Australian-dollar denominated assets are likely to offer positive returns.
'The investor could simply switch into Australian dollar deposits or for the more informed players, willing to take on higher risk, Australian equities might be worth thinking about,' says Mr Edwards - though the risk to this scenario is that exchange rate settings may be reversed 'quite quickly'.
'The RBA is determined to slow economic growth quite sharply in order to combat rising inflation, and it is possible that if we are tightening here and global growth is slowing, we could slow quite sharply in which case rates would come down and the aussie would come off quite quickly,' he says.
Mark Konyn, Hong Kong-based chief executive (Asia-Pacific) for fund manager RCM, echoes the view that the immediate trend for the Australian dollar remains positive, but the outlook for sustained economic growth through the remainder of the year is clouded.
'On a relative basis the economy remains sound and therefore we would not expect a major downward adjustment in the near-term.
'The combination of higher yields and support from flows will continue to hold valid for the moment at least,' Mr Konyn says.
But under the weight of further increases in rates by the central bank, if the Australian economy begins to slow down, the RBA may act decisively and cut rates quickly.
'At this point, the higher yield status will erode and we could see some downward pressure on the Aussie dollar.
'The negative savings rate and relatively high level of household debt may cause a sharper slowdown than is currently expected - but this is further down the track.'
Notwithstanding the risks, the Australian dollar remains a 'very popular' trade among self-directed investors that use online currency trading portals, according to Siju Daniel, managing director of trading portal FXCM Asia.
'The story is still about the US and interest rate outlooks and, with the US Federal Reserve expected to continue cutting rates, the Australian dollar will remain a popular punt for high-yield reasons,' Mr Daniel says.
Sounding a note of caution, Arjuna Mahendran, chief economist and strategist, Asia-Pacific for the private banking division of Credit Suisse, says as long as the Australian dollar remains of perennial interest to many investors in Southeast Asia, the country will be able to fund the deficit on its external account by way of inflows of capital.
'But the magnitude of the deficit - at 6per cent of GDP - creates a particular vulnerability. This is because even though Australia is now able to fund its deficit quite comfortably, because of these capital inflows in periods of marked risk aversion such as we have seen since October last year, you find that all currencies of countries which have these deficits tend to get sold off.'
But Mr Mahendran expects US economic growth to tread higher in the second quarter and spur risk appetites which will be positive for the Australian dollar.
'So in the next six months we will probably see the dollar peak at about 92 US cents, though later in the year the US will likely begin recovering and the rate will trend back towards 90 US cents.'
The simplest way for an investor to profit from the currency movements, he says, will be to convert Hong Kong dollar deposits into Australian dollar deposits, although the Japanese yen may also come into favour.
Norman Villamin, Singapore-based head of research and strategy for investments for Citi Global Wealth Management, says the Australian dollar is likely to trade in a range of 90 to 95 US cents during the year, supported at these levels by the strength of commodity prices and rising Australian dollar interest rates.
'Iron ore, coal and gold comprise about 43 per cent of Australia's commodity export basket and the price outlook for all three is very positive,' Mr Villamin says. 'We have recently raised our forecasts of prices for coking coal and coal, which we now expect to double over the course of the year, while iron ore prices are forecast to rise by 60 per cent and gold will stabilise above US$1,000 per ounce in 2009-10.'
On the interest rate front it is clear that the RBA is committed to bringing inflation under control.
'The RBA would be happy to see a moderation in global economic activity taking some of the pressure off the Australian dollar, but absent this, as we have seen recently, they are moving rates higher to try and slow economic growth down.'
The outcome of these twin forces for the currency will be positive, Mr Villamin says, and the Australian dollar is likely to trade in a range of 90 to 95 US cents during the year with the risk to this scenario being a 'fairly fluid' global economic environment and the sensitivity of the Australian currency, and economic growth to unfolding events in the mainland.
Eric Wong Yat-wah, FX and investment strategist, DBS Bank (Hong Kong), echoes the sentiments on commodity prices underpinning the exchange value of the Australian dollar.
'Although the US economy is shrinking, other major economies will stay well-supported so long as there is no major US economic downturn this year,' Mr Wong says.
Against this background, demand for soft and hard commodities will be strong well beyond 2008, and the Australian dollar will also be supported by increases to interest rates by the RBA.