In the last few days we have been given another sneak preview into what happens when the US begins to taper its money printing via quantitative easing. And there are also some early signs that China may be changing direction. Any Chinese setback will have a similar effect on the Australian currency, commodities and shares as an end to US quantitative easing. The Australian dollar fell 3 cents in seven trading days to October 31, although it is now stabilising.
In the case of the US, the next month or two should see a volley of bad economic news in reaction to the debt crisis so any serious push to taper quantitative easing is more likely to take place in 2014 than 2013 (A tough job for the Fed in 2014, October 31).
As we have just seen in miniature, when tapering happens it strengthens the US dollar as American interest rates rise and it lowers the Australian currency while putting downward pressure on share prices and commodities. My belief is that the nasties associated with the end of US tapering will cause quantitative easing to continue for much longer than most expect but one cannot be certain. And we should not forget the underlying strength in the American economy compared to most other parts of the world, particularly given its changed energy outlook.
Of probably greater importance to Australia is what is happening in China.
At the start of the year China was attempting to lessen its export growth and dependence on infrastructure investment for prosperity. When the Chinese leadership saw firsthand the adverse implications of the slowdown they began pumping the economy once again and Australia has been a major beneficiary via iron ore and other commodity price rises. Even the battered thermal coal market has been improving.
But over the last two or three months, Chinese steel prices have been weakening and usually they are a good lead indicator of Chinese activity. Although in recent days steel prices have stabilised, the steel price fall indicates that the country's recovery may have lost momentum, which could lead to weaker manufacturing data in coming months.
Australia is in the front line of any China setback. Australia also faces a period where we will see significant falls in mining investment, which will be cushioned to some extent by the growing appetite for housing and later infrastructure.