The Australian dollar has put in a stellar performance since the beginning of March having gained around 6 per cent against the US dollar and 3.1 per cent against the yen. Rising commodity prices and Australia’s 6 per cent plus interest rates have formed a potent cocktail for the unit – particularly given the financial market’s preoccupation with yield differentials. Moreover, positive economic momentum underpinned by a particularly healthy labour market have bolstered the view that there is more to come from the Reserve Bank of Australia (RBA). Market confidence in this view was underpinned by a recent speech from RBA assistant governor, Malcolm Edey, who noted that “information since [the Bank’s February forecast] suggests that some of the factors pushing up underlying inflation last year remain in place”.
Yet although the Australian dollar appears well placed to enjoy further gains on this basis, there is also the question of valuation at a time of particularly high risk-tolerance fuelled by liquidity (a number of currency pairs and yen crosses in particular have risen to levels hard to justify on the basis of underlying interest rate differentials). The Aussie unit now appears to have become settled above the 0.81 cents level and whilst each area of underlying support for the unit receives such a glowing endorsement, it is hard to see what could preclude the market’s concerted assault on the 82-cent level.
However, by playing on the market’s psyche, it could well be that non-tangential factors offer the greatest downside risk to the unit. Indeed, if only to emphasise the rarity of occasions on which the Australian dollar has traded at current levels, it is worth reminding ourselves of the following observations.
Australian dollar/dollar is currently trading c. 15 per cent above its post-1990 average (or c. 23 per cent above its post-2000 average) while one-year yield support is currently 140 basis points – around 35 basis points below its 17-year mean.
Average yield support in 1990 – when the Australian dollar last spent any sustained period above 80 cents – was 492 basis points. (For the 27 week period in 1988/89, the yield support ranged from 500-900 basis points).
Current yield support is one third of that seen at the start of January 2004, and around one half that of February/March 2005 when the Australian dollar last had runs at the 80 cent level.
For a spread within 10 basis points of the current one-year yield gap this past 17 years, the average spot price over the period has been 0.717 cents or 12 per cent below the current level.
Resistance associated with the 80 cent level has brought an end to the following trends: the 24 per cent rally from September 1993 to May 1996; the 64 per cent rally from October 2001 to February 2004; the 15 per cent rally from October 2004 to March 2005.
Aside from its revival in late-1988 and early-1989 and its recent performance, the currency’s most sustained phase above the 80 cents level occurred in 1990, when, during a nine-week period from mid-August to mid-October it averaged 82.2. Since then, however, the 80 handle has been a rare occurrence with a two-week period towards the end of 1996 the currency’s most notable achievement in this respect.
Whether these observations have any implications for the medium term performance of the Australian dollar remains to be seen. But in view of the history of the Australian dollar’s performance around current levels since 1990, it is certainly possible that a nervous awareness of history may grow with or without any reappraisal of appropriate levels of risk or any reappraisal of the outlook for the dollar.
Neil Mellor is a currency strategist at the Bank of New York.
Researched and published in association with the Bank of New York.
