A history lesson for the Aussie dollar

In the absence of a crisis, it’s not likely the local currency will trade at US60c or below for any length of time.

Summary: The call for the Australian dollar to head toward US 60 cents is a very big call. If history is any guide, we need to see a crisis for the Aussie dollar to hit US60 cents or below for any length of time. In the absence of that it’s not likely we’ll get there, I would suggest.

Key take-out: It is looking like the dollar will be weaker for longer. Nonetheless I maintain my view that as it becomes clearer the Australian economy isn’t falling into a heap, the currency will appreciate.

Key beneficiaries: General investors. Category: Economy.

With the Aussie dollar ducking its head below the US70 cent mark recently, the talk now is that the currency could head toward US60 cents. Some even talk of a unit at the US50 cent level.

Admittedly, the price action has been bearish looking beyond the rebound of the last four days. The recent low of US69.1 cents was the lowest since the GFC, and prior to that, 2004.

Now I have to be upfront when it comes to the Aussie dollar – I’ve been very wrong. While forecasting currencies is a mug’s game as the old saying goes, I’m genuinely surprised, firstly at the level the currency is at, and secondly, the length of time we’ve seen it down here. Effectively I’ve misjudged the extent to which the market would be bearish on the Aussie dollar – although to be fair I haven’t been alone on that front.

Back in May we had just witnessed the biggest contraction in short (sold) positons on the Aussie currency in history and the unit shot back up to US81 cents. Moreover, analyst forecasts have generally been following the Aussie dollar down as well, rather than providing any predicative accuracy. That’s not to be insulting, it’s simply a testament as to how difficult forecasting the Aussie dollar has been and how unexpected its weakness really is.

What’s interesting about this current bout of weakness is that it has occurred independently of the US dollar. That’s very unusual as most of the weakness in the Aussie dollar, practically all of it over the last year, has been more about US dollar strength (nothing to do with the terms of trade or RBA rate cuts). It was only a year ago that the Aussie dollar was over US90 cents, and the subsequent drop was driven by a 25 per cent spike in the US dollar. That isn’t the case now and the latest 4 ½ cent drop we saw to US69.1 cents (from mid-August to early September) occurred at a time the US dollar was actually weakening. So the Aussie dollar has decoupled.

All that said and done, it still remains the case that the call for the Aussie dollar to head toward US60 cents is a very big call.

Have a think about the historical context. Chart 1 below may help in that regard.

Chart 1: The post-float Australian dollar

Source: Bloomberg

As you can see from the chart, the Australian dollar has only been around the US60 cent mark, or below, on three occasions since the float in 1983. The first was in 1986, the second 12 years later from 1998-2003, and then finally during the GFC.

Now what’s important to note in each case, is that the Aussie dollar didn’t just find its way down to the US60 cent mark by accident, or even on some bearish trading momentum. Indeed, on all three occasions there was a very tangible sense of crisis. Only three years after the float, Australia faced a balance of payments crisis and surging foreign debt. This led the then treasurer Paul Keating to famously declare that Australia risked becoming a banana republic.

Then during the five-year period from 1998-2003, there were a number of sizeable catalysts that drove the Aussie dollar down – admittedly for a lengthy period of time. Have a look at what was going on though.

In the US, it was the dot.com bubble. The Nasdaq surged nearly 200 per cent, which in turn drove a 30 per cent spike in the US dollar index as foreign money poured into America’s ‘new economy’. Australia was viewed as an ‘old economy’ and so the Aussie dollar was overlooked. Especially as the Asian financial crisis fired up. This lasted for two years from 1997 to 1999 and the Aussie dollar was smashed.

Ironically, as the dot.com bubble burst, safe haven flows into US Treasuries surged which once again acted to support the US dollar. Bonds rallied hard and yields fell about 3.6 per cent. Again, all of this was very negative for the Australian dollar. Then of course there were the September 11 terrorist attacks which saw another bout of safe haven flows which tend to see ‘riskier’ currencies like the Aussie dollar weaken.

Now I can appreciate that there is no shortage of risks that are still out there at the moment, whether that’s weaker-than-expected growth here, or in China, or some sort of global financial shock. I’m not big on highlighting them often I realise. That isn’t because I overlook them. Partly it’s because they are only low probability risks. Not a base case scenario. It’s also because I know you’re getting more than enough of that from other sources. So there is no need.

Even so, and even if these risks had a high probability, which in my opinion they don’t, that is still a very different set of economic metrics to a crisis. Yet if history is any guide, we actually neeed to see a crisis for the Aussie dollar to hit US60 cents or below for any length of time.

In the absence of that it’s not likely that we’ll get there, I would suggest. Nor should we really want it there.

All that said, it is looking like the dollar will be weaker for longer. Nonetheless I maintain my view that as it becomes clearer that the Australian economy isn’t falling into a heap and that the Chinese economy isn’t having a hard landing, the currency will appreciate. If the Fed tightens this week, not looking likely, the Aussie dollar could head lower. Yet on a longer-term view, once the Fed starts to tighten, the RBA usually follows suit as well. So any currency effect from a Fed hike should prove short-lived.

Currency moves have been large and rapid over the last year, that is true. But that in itself doesn’t mean the Aussie dollar will continue to collapse.