The weakening in the Australian dollar seen over the past few weeks has no doubt come as a welcome respite for what remains of the Australian manufacturing sector, establishing what is likely to be a sustained new trading range, for the time being.
Australian Dollar and Interest Rates
While the Reserve Bank of Australia, yesterday, left interest rates on hold – at 2.75%, the Australian dollar continued to weaken, currently sitting at 0.9645 vs the US dollar.
Why is this?
Latest statistics from the Australian Bureau of Statistics showed the economy continuing to expand – growing 0.6% for the first quarter of 2013, or 2.5% annually. However, expectations were higher, with economists and market watchers looking for 0.8% and 2.7% respectively. Net exports make up around 1% of this so in reality, not overly flash once past the initial headline number.
Against a backdrop of declines and even contractions by many of the major economies, relatively it’s not so bad – but relatively is arguably not the benchmark. On an absolute basis, and with a mature and sizeable contribution coming from the mining sector, things should be better. The area of concern is related to confidence – with business confidence far from booming, and domestic demand being impacted by the labour market and job insecurity. Recent hits to mining services, the public service and Ford, all being examples of the fragile state of the job market.
This level of uncertainty and the outlook it brings, presents a reasonable case for further rate cuts, with the Reserve Bank, keeping their powder dry, for this month, at least.
Looking across the currency markets, the view would seem to be pricing in at least a further rate cut and possibly more, as the RBA weigh up the pros and cons of easing rates slowly, to assess impact – a prudent approach – compared to a sharp series of cuts. The latter would certainly not give a positive message to the market.
At a basic level, lower interest rates mean it is less attractive holding Australian Dollar based assets or cash, prompting flows out of the dollar and selling pressure on the currency.
In our Outrageous Predictions for 2013, back in December 2012, we expected to see up to 75bps shaved from interest rates – we are 1/3rd of the way there and as we also stated, see 96c as a bottom of the trading range, at least in the immediate term.
Where else can you look?
With lower rates, it effectively becomes less attractive holding cash in the bank and, if cash is “forced” back into the economy, there are obviously beneficiaries. Consumer spending, locally rather than on-line, will no doubt pick up, and we would suggest so too, would the broader equity market, as stocks should be natural beneficiaries from reduced cash holdings.
Trade idea wise, the immediate and short term move in the Aussie dollar has been and gone, for the immediate future, and we hope you got your share of it, basis our predictions.
However, there will be further opportunities in the market too – retail may enjoy a welcome respite, although Billabong is not on our list to buy, for so many reasons! Also exporters who are bringing back overseas revenue will enjoy an enhancement to their margins, courtesy of the 8% move we have seen to date from the Aussie.
Sector and Stock
Sector and stock wise, we may again return to the “yield plays” such as the banks and Telstra, all of which have had recent pull-backs and are looking more attractively valued. These have been kind to us, earlier in the year and it could be time to reload. Telstra, for example, is on a dividend yield of 6% (fully franked) – very attractive compared to current interest on cash at the bank. That said, and Telstra specific, the asbestos fall out, as well as its low growth trajectory are areas to be mindful of, in terms of risk on the trade.
Low Interest rate
So a lower interest rate environment will see a weaker Australian dollar, with beneficiaries including shares and property. The RBA is playing its hand – a tough hand – quite well, with its policy of gradual easing. That said domestically, if things are weaker than they seem right now, then a more direct “heart starter” may be in order, kick starting confidence. One thing for sure, as always, there will be profit making opportunities available for those who step up – across both the FX (Forex) and equity markets.