UP 'Down Under' Dollar

In terms of fixed income, you can’t get much better than an Australian Government Bond. A 1 year government bond in Australia is currently yielding 4.54%. Compare that to a 1 year Government of Canada bond at 1.16% and it looks pretty appealing. This is especially attractive given that Moody’s rates them as Aaa. So what’s the catch? The catch is the currency risk. A movement in the Australian dollar vs. the Canadian dollar could easily wipe out that 3.5% premium. On the flip side, it may give you a nice bump in return if the Australian dollar appreciates relative to the Canadian dollar.

Over the last year the Canadian dollar has appreciated against the Australian dollar. It is currently trading at $1.11 Canadian dollars to 1 Australian dollar. At this time last year the Canadian dollar was trading at $1.10. Between June and November, the Canadian dollar fell to $1.01 and then rose to a high of $1.16 recently. In the last 2 weeks, the Canadian dollar has fallen relative to the Australian dollar. In the last 10 years, the Canadian dollar has been as high as $1.32 and as low as $.9552 against the Australian dollar. Generally the currency establishes a longer term trend and sticks to it for awhile. Are we at a point where there is may be a reversal of trend? The current price is about to hit the 50 day moving average to the downside and both MACD and relative strength are looking bearish. In the last two years, the trend for the Canadian dollar has been negative relative to the Australian dollar with the exception of the most recent period from last November till now. If we are about to see a reversal of this most recent trend, it will benefit Australian bond holders in Canada.

According to Wikipedia, “the Australian dollar is currently the fifth most traded currency in the world foreign exchange markets behind the US dollar, the euro, the yen and the pound sterling…The Australian dollar is popular with currency traders due to comparatively high interest rates in Australia, the relative freedom of foreign exchange market from government intervention, the general stability of Australia’s economy and political system, and the prevailing view that the Australian dollar offers diversification benefits…, especially because of its greater exposure to Asian economies and the commodities cycle.” Since the balance of trade depends on commodity exports such as minerals and agriculture, the relative value will fluctuate with the booms and busts of global demand or when domestic spending overshadows the export earnings outlook. This is generally different than other major currencies as traders tend to move to cash when stocks are falling, therefore bumping up the currency. Canada’s currency is also sensitive to commodities but keep in mind that 75% of our exports go to the US and the challenges there appear to be increasing with their debt. Don Coxe argues in his recent Basic Points article that “of the industrial world’s currencies only the Canadian dollar now boasts the qualities of endogenous strength and political reliability that could make global investors prize it as a secure, tradable store of value from a long-term standpoint.”
Despite this, I think the Australian dollar may emerge with some strength given today’s news that China is easing its peg to the US dollar. I would expect further increases in the Australian dollar relative to the Canadian dollar. According to Australia’s exports fact sheet, China is Australia’s largest merchandise export market, accounting for $42.4 billion in 2009. In addition, according to The Australian, “Russia may add the Australian dollars to its international reserves for the first time after fluctuations in the US dollars and the euro.” There appears to be some supportive indicators suggesting a reversal “down under”.