Forex Investment and Currency Trading

• Despite a sharp drop in consumer and business sentiment in the first quarter which has bled into the second quarter, Australian GDP growth once again surprised to the upside in 1Q 2008.
• Residential investment and exports are now the slowest categories of GDP. Export growth has been constrained by weather disruptions and the slow infrastructure build. The deceleration of residential investment is not the start of a cycle similar to that in the US because underlying demand for housing continues to run at a faster pace than new supply, but has run into competition for scarce materials and labor from non residential investment.
• The current account gap hit a peak of 6.9%/GDP in 1Q 2008. The FDI account is roughly balanced, with little appetite to ‘give away’ ownership of resource companies. Australia has a net outflow into foreign equities as pension vehicles and the Future Fund increase their exposure to foreign assets. Debt flows and “other investment” continue to drive the financing of the current account gap.
• Coal and iron ore contract prices, 1/3rd of the RBA commodity basket, should increase by about 150% this year. With other commodity prices in the basket about net flat in 1H 2008 (first up then down), this implies a 50% gain in the RBA commodity basket through July.
• In its May monetary policy statement the RBA estimated that Australia’s terms of trade this year would rise by about 20% based on this expected gain in the commodity price index. If so, Australia will have experienced about a 65% gain in terms of trade since 1Q 2003, equivalent to the ToT gain in Russia and well above that in the next best countries (Norway 44%, Canada and NZ 18%). The RBA uses a chart underlining its contention that ‘rise of the exchange rate over recent months had been less than might have been expected given the strength of commodity prices’ (May meeting minutes).

Monetary Policy and the Exchange Rate

• Market expects AUD/USD to exceed parity at least temporarily in 2H 2008 as (a) monetary conditions still appear accommodative based on a record current account gap despite a half-century high on terms of trade, and (b) with domestic demand slowing relatively to the external stimulus in the year ahead, more of the tightening of monetary conditions may come in the form of currency appreciation. AUD often outperforms the European majors in a mature commodity cycle phase.