Excavators move iron ore at the port in Port Hedland, Australia, in March 2019. Port Hedland is the nexus of Australia’s iron ore industry. Photo: Bloomberg
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley
How US, China Covid-19 recovery policies threaten the Australian dollar
The threat posed to the currency by the arrival of the Delta variant on Australia’s shores is compounded by policy developments in Beijing and Washington
Interest rate changes in the US and Chinese efforts to put the country’s recovery on a more sustainable footing could adversely affect Australia’s iron ore exports
When tectonic plates move, tremors can be felt in the most unlikely of places. With China and the United States, the world’s two largest economies, now crafting tailored but contrasting fiscal and monetary policy responses in their respective exits from the Covid-19 pandemic, tremors will be felt in the foreign exchange markets. Some currencies will be shaken, and one that might prove vulnerable is the Australian dollar.
The end of the pandemic does not mean the end of this coronavirus. Covid-19 will still be with us, and society will have to adapt to live with it. The pandemic might pass, but the virus will become endemic. In the case of Australia, that health reality might prove something of an obstacle to the country’s economic recovery from the pandemic.
Australia’s initial success in containing the spread of Covid-19 owed much to lockdowns and the effective closure of the country’s borders. However, Australia has been slower than many other countries in rolling out vaccinations that provide substantive protection against the virus.
The more transmissible Delta variant of Covid-19 has reached Australia’s shores, despite the restrictions on people entering the country. Australia is again applying strict lockdowns, which will have negative knock-on economic impacts. Although Canberra is now emphasising that the pathway out of the pandemic involves a faster pace of immunisation, the country cannot yet rely on mass vaccination to help curb the variant’s spread and mitigate its effect.
05:33
Covid-19 Delta variant: how infectious it is and how it may ‘shift thinking’ on countries reopening
Covid-19 Delta variant: how infectious it is and how it may ‘shift thinking’ on countries reopening
This situation alone hardly seems supportive of the Australian dollar on the foreign exchanges, but the risk that the currency weakens is compounded by policy developments in Beijing and Washington.
With the US Federal Reserve appearing to be edging towards a less dovish position recently, the US dollar has benefited generally as markets contemplate tighter US monetary policy conditions earlier than had been expected.
At the same time, investors will not be oblivious to the investment opportunities that will accrue in funding ever-larger US spending programmes. The Biden administration has essentially linked its longer-term commitment to reconfigure the US economy along greener lines to its shorter-term “build back better” post-pandemic recovery agenda.
Overseas investors will necessarily require US dollars to participate. But the currency’s strength isn’t just evidenced on the currency markets, given that commodities such as iron ore, a key export for Australia, are priced in US dollars.
Not being yield-bearing in themselves, “commodities by nature are negative carry and are priced in [US] dollars”, as Geoffrey Yu, senior market strategist for Europe, the Middle East and Africa at US bank BNY Mellon, noted last week, “so higher US real rates in the absence of stronger demand will hurt prices”.
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Will iron ore be dragged into the ongoing China-Australia trade conflict?
Will iron ore be dragged into the ongoing China-Australia trade conflict?
To the extent that the foreign exchanges regard the Australian dollar as a commodity currency, a lower price for iron ore might well be seen as a negative for the Australian dollar.
This is where China’s policy settings might have an impact. It was clear from Beijing’s reaction to the pandemic that the hurdle for China to roll out credit stimulus in support of the economy seemed higher than previously.
As Dario Perkins and Rory Green, both at London-based independent research provider TS Lombard, pointed out on June 30, “in 2020 China’s Covid stimulus was 3 per cent of gross domestic product, compared to 10 per cent of GDP in the US, 16 per cent in Germany and 14.5 per cent in France”. In fact, “since 2017 the [Communist Party] has shifted focus from credit-fuelled expansion to an emphasis on slower, sustainable development”.
China’s demand for Australian iron ore might have soared again in May, but in the same month Beijing ordered Chinese steelmakers to start scaling back production from June, partly in a bid to avoid overcapacity. This is a policy which correlates to the wider objective of setting China’s economy on a path to more sustainable development.
Markets might infer that China’s future demand for Australian iron ore will be trimmed back, a perception that is likely to weigh on the price of that commodity. In turn, in the currency space, that could also lessen the attractiveness of the Australian dollar.
Australia’s struggle with Covid-19 continues. Meanwhile, in Beijing and Washington, policymakers are unveiling tailored but markedly contrasting approaches for post-pandemic economic recovery.
The US approach might help underpin demand for the US dollar generally. China’s approach might help support the renminbi but also indirectly undermine arguments in favour of the Australian dollar, which now looks somewhat vulnerable.
Neal Kimberley is a commentator on macroeconomics and financial markets
