Australian Dollar Forecast to Benefit in New Iron Ore Grab
The Australian Dollar is forecast to undergo a period of appreciation as the new Trump-China-Iron Ore price dynamic unfolds.
The Aus Dollar is one of the better performing G10 currency in the week 21-25 November 2016.
The performance comes as foreign exchange traders turn their focus on the sharp rebound in the iron ore market where prices rose 8% in mid-week trade alon.
And when demand for Australia's number one export rises so too does the currency.
"Chinese investors are piling into commodities as the US dollar continues to strengthen and as China allows its currency to depreciate against the US dollar," says John Mayer, an analyst with brokers SP Angel in London.
Iron ore is Australia's largest export commodity and accounts for the lion's share of the export trade component of the country's current account.
"The sudden surge in demand for iron ore is being attributed to some adjustment in Chinese supply, but it may also be a result of speculation that any infrastructure plans by US President-elect Donald Trump would require a massive increase in steel," notes Boris Schlossberg at BK Asset Management in New York.
And, according to analysts at foreign exchange brokers HiFX we could actually be witnessing the beginning of a new dynamic which could see the Australian Dollar make protracted gains.
The Australian Dollar rose to a multi-decade high in 2013 as the most recent commodities boom, lead by Chinese demand, unfolded.
It has since pared these gains as Chinese growth, and with it demand for iron ore, receded.
Chinese Iron Ore Demand in Reaction to Trump
HiFX believe that a new period of appreciation for iron prices and their Aussie Dollar bedfellow could be on the cards.
Rising iron ore prices are said by HiFX to reflect China’s pre-emptive reaction to Trump’s policy agenda.
The Chinese are expected to do several things to offset the imposition of a trade tariff.
The first is to keep their currency weak.
“The Chinese might also keep weakening the value of the Yuan to offset any trade tariffs that Trump might impose on them,” said HiFX in a briefing on the matter to clients.
A weak Yuan combined with a stronger Dollar - as seems increasingly likely – could take much of the financial sting out of even quite substantial tariffs, which are currently expected to be in the region of 45%.
The problem with maintaining a week Yuan for the Chinese, however, is that it will hurt Chinese manufacturers who will have to absorb increasingly punitive rises in their base production costs due to increasingly more expensive imported resources, commodities, and components.
“So ahead of a weakening currency it will pay China to stockpile as many hard commodities as possible,” remark HiFX.
Indeed, the recent rise in, “the price of Gold, Iron Ore and Copper,” are as a result of Chinese ramping up their buying in these markets.
It may also be that the Chinese fear a commodity boom due to the US’s massive infrastructure spending plans which will be resource intensive.
“These moves should be positive for the Australia Dollar which has been weak of late and we have seen the NZ Dollar drop sharply vs the Aussie Dollar overnight.
“China has the capacity to stockpile the hard commodities that Australia produces whereas New Zealand’s soft commodities do not lend themselves to being stored for long periods.
“This should help the Aussie Dollar stage a rebound vs the NZD over time,” conclude HIFX in their note.
Don't Bet on the Aussie Dollar Yet
However, not everyone is convinced that we are witnessing a cyclical upturn for iron ore.
Morgan Stanley have in their latest foreign exchange briefing confirmed to clients they remain structurally bearish on the Australian Dollar.
"We are structurally bearish AUD and expect it to underperform NZD," say Morgan Stanley. "The market has priced too hawkish a path for the RBA given weak employment data and our expectation for a negative 3Q GDP print."
Importantly, Morgan Stanley say Australia will be hurt as China's mini-cycle recovery slows, as we already see in the housing data.
This slowdown in housing would be at odds with the argument that China is gearing up to absorb more commodities.
It does also suggest that the current commodity stockpiling is more speculative than fundamentally justified.
While the RBA may not cut rates for the foreseeable future, Morgan Stanley believe it will make sure the market reflects its easing bias, weakening AUD.
"AUD is also particularly vulnerable to rising US interest rates given its high yield (relatively speaking) status and current account deficit," say Morgan Stanley.
