Currencies | May 01 2014
This story features JAMES HARDIE INDUSTRIES PLC, and other companies. For more info SHARE ANALYSIS: JHX
-More normal US, UK rates likely
-AUD likely to fall vs USD, GBP
-Focus on key industrial stocks
-Long AUD not appropriate
By Eva Brocklehurst
One of the currency moves that surprised equity tacticians this year was the strength in the Australian dollar. Citi thinks the rebound is being broadly sustained against the backdrop of a slowly rising US dollar, so the causes are on both sides of the currency pair. Still, the analysts believe there's more room on the downside as Australia's terms of trade are likely to weaken further, while growth picks up in developed economies.
Citi thinks the outlook for the Australian dollar is complicated by the divergence in growth among the developed economies. The US Federal Reserve is expected to phase out quantitative easing this year and the Bank of England is already doing so. The Bank of Japan is expected to go the other way and step up monetary easing, while Citi economists think the European Central Bank might introduce quantitative easing this year. Consequently, a return to more normal interest rates is expected in the US and UK over the next few years while Europe and Japan lag.
On this basis, the analysts think the US dollar and British pound will rise against the Japanese yen and euro. The strong appreciation of the Australian dollar over the past decade has been more against a weaker US dollar than against the euro and yen. Hence, the risk, in Citi's view, is for the Australian dollar to fall against USD and GBP, but rise against JPY and EUR as the trade weighted index falls overall.
For local equity portfolios this could be important, given the share of market earnings from abroad for significant industrial stocks. While important for resources, the influence is less straight forward because of the Australian dollar's tendency to move with commodity prices. These potential moves in the major currencies suggest to Citi that investors should focus on earnings in USD and GBP, which means industrials such as James Hardie ((JHX)), Incitec Pivot ((IPL)), Henderson ((HGG)), Ansell ((ANN)), News Corp ((NWS)), Aristocrat ((ALL)) and Computershare ((CPU)), and less so the more diversified offshore exposures such as Brambles ((BXB)), Amcor ((AMC)), Macquarie Group ((MQG)), Cochlear ((COH)), ResMed ((RMD)) and CSL ((CSL)).
ANZ currency strategists expect the US dollar to remain in a broad range, with growth not fast enough to push it sharply higher but strong enough to underpin the currency. Volatility is extremely low and the strategists advise investors to focus on currencies where growth prospects are improving. The analysts believe the Australian dollar has overshot the fundamentals and remains vulnerable to a sell off. The local dollar seems to be caught between its traditional fundamental underpinnings and global liquidity. Liquidity dominates at present but the analysts believe this is temporary. They believe the Reserve Bank will have to start raising the cash rate in 2015 but he economic upturn is unlikely to be smooth, as confidence ebbs with a tighter fiscal setting post the federal budget and the decline in mining investment peaks.
The analysts believe any outperformance in Australia's economy is more than priced into the currency at this point. The recent rebound from US90c was driven by a positive shift in perceptions regarding the trajectory of the Australian economy and a downplaying of the immediate risks surrounding the Chinese financial system, as well as a loss of momentum in US data. Now, ANZ's analysts believe the Australian dollar is in a position where it's strength is being underpinned by momentum, liquidity, and not much else. Moreover, May is a seasonally weaker period for commodity prices as post-winter re-stocking wanes in the northern hemisphere. Hence, the analysts expect the Australian dollar to trade lower in the next month. This is not an attractive situation for a medium term investor, they argue, and being long the Australian dollar is therefore not appropriate.
On the crosses, the analysts expect the Aussie to outperform against the New Zealand dollar and weaken against the pound and euro. ANZ analysts differ from Citi in that they see the euro's rally as not having much impact on growth in that region and, with global risks still centred in Asia, the Australian dollar is expected to decline against the euro.
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