Australian Dollar

Over the last two months, the South African Rand has plummeted, losing nearly 20% of its value against the US Dollar en route to a five-year low. It seems the currency has become the latest victim of the credit crisis and the resulting widespread risk aversion. The sudden exodus away from the carry trade, for example, has affected the Rand disproportionately, as many foreign investors had come to South Africa over the last few years to take advantage of the country's 12% interest rate. Now, the country is facing a horrible crisis, and is worrying about its ability to finance its current account deficit, which already exceeds 7% of GDP. Accordingly, analysts predict the Rand will continue to drop. Bloomberg News reports:

I won't lie; the Forex Blog is admittedly Dollar-centric, in that developments in forex markets are usually assessed relative to their projected impact on the US Dollar. Sometimes, we forget that their are other currency pairs that move irrespective of the Dollar. Take the Australian Dollar and New Zealand Kiwi, for example. As both currencies are backed by high interest rates, they have benefited equally from the carry trade and as a result, they behave quite similarly. Combined with the fact that they are practically neighbors, it's easy to forget that there are unique circumstances that weigh separately on them.

The parallels between the Australian Dollar and the Canadian Dollar are remarkable! Both currencies are backed by economies highly dependent on natural resources. Both countries' Central Banks are considering rate cuts in response to slowing growth. Finally, both currencies have slipped well below parity with the US Dollar. Unlike the Canadian Loonie, the AUD had never quite breached the mythical 1:1 level with the USD. Furthermore, given the deteriorating economic picture in Australia, parity is off the table for a long time.

By one measure, the US Dollar has lost 33.8% of its value under President George Bush, its worst performance by far under any one administration. The burgeoning twin deficits, lackluster economic performance, as well as the current environment of stagflation have all contributed to a dramatic and unprecedented loss of confidence in the Dollar. While investors are understandably optimistic about the prospect of a new President, come January, they are ambivalent as to whether it is Barack Obama or instead John McCain that is ultimately elected. Since the Dollar seems to have bottomed out anyway, the new President stands to preside over a recovery of the Dollar. Reuters reports:

After a brief hiatus, the Australian Dollar has resumed its upward march against the Dollar; its next milestone will be a 25-year high against the Greenback. Of course, its continued strength is due to a combination of high domestic interest rates and high commodity prices. In fact, its performance seems to mirror the price of gold, which is no coincidence since gold may be Australia's most valuable export. In addition, gold has value as a monetary instrument, which means an appreciation in gold can give the Australian Dollar a double-boost by lifting it while simultaneously punishing the US Dollar. With regard its domestic monetary policy, Australian inflation recently passed the 4% mark, which means interest rates (already at 7.25%) are likely to stay high for a while.

sOnly last year, the idea that the Australian Dollar would ever reach parity with the USD was laughable. Then, earlier this year, it became plausible. Now, according to an informal poll of analysts, it is not only possible, but likely. AUD bulls should look no further than the rapid surge in commodity prices, which may boost the total value of Australian exports by 20%, including a 30% rise in its commodity exports. In short, the Australian economy has boomed, and inflation is slowly creeping up. The consensus among economists is that the Royal Bank of Australia will leave its benchmark lending rate unchanged at 7.25% for the duration of the year. At the very least, it won't lower rates, which is all analysts need to believe in order to get behind its currency.