Business
  1. Home
  2. Business
  3. Markets
Save
Print
License article

CME Group says slowing China, high debt pose risks for the Australian dollar

Patrick Commins
62 reading now

From its lows of below US50¢ in 2001 to its highs of $US1.10 in 2015, the Aussie dollar's trading range has been "gigantic", CME Group senior economist Erik Norland marvels.

At around US75¢ the local currency now trades almost exactly at its 34-year median against the greenback. Which begs the question: Where to from here?

Up Next

The last car maker in Australia

null
Video duration
00:59

More BusinessDay Videos

null
Video duration
02:34

GDP slows less than estimated
null
Video duration
00:59

The last car maker in Australia
null
Video duration
00:43

ASX winners and losers - a snapshot
null
Video duration
01:45

Sydney house prices not falling
null
Video duration
00:54

How much can you save at Aldi?
More videos

GDP slows less than estimated

With interest rates expected to be on hold for the rest of the year, Morgan Stanley Australia Strategist Daniel Blake says the economy is a victim of its own success.

"The Aussie has dropped 35 per cent or so off its highs, but that doesn't necessarily mean that it has finished dropping," Mr Norland warned at a briefing in Sydney on Thursday.

"Where the currency is trading now doesn't look particularly aberrant either up or down," he said. But the balance of risks tend to point towards a move lower.

Indeed, the London-based American economist can envisage a scenario in which the Aussie dollar is back to plumbing those lows reached just after the turn of the millenium.

"The Australian dollar could revisit it's all-time lows; [I don't have] an extremely high level of conviction, but I think the risks are there: either its 2008 low of US60¢, or maybe even lower."

Advertisement

The key factors to another sharp leg lower would be a slowing China and much lower commodity prices, in particular that of iron ore.

"The Australian dollar correlates very highly to certain commodities, including iron ore and coal prices," Mr Norland said. While these raw materials might be Australia's two biggest exports, they only equate to about 5 per cent of the country's gross domestic product, which means it is "possible to exaggerate the importance of these exports", he noted.

"But they are both exported in great quantities to China; they are like canaries in the coal mine in terms of how the Chinese economy is doing, and we think there are a lot of reasons to be concerned about China."

Chief among those concerns is that Chinese policymakers have reached the end of a massive debt-fuelled stimulus and authorities have now transitioned to worrying about how to reduce the country's leverage.

"As they crack down on lending it is possible that their housing and construction markets will go into reverse, which would be very, very bad news for iron ore," Mr Norland said.

China consumes two-thirds of the world's iron ore supply. And its waning appetite and still massive supply of the steel-making ingredient make for unattractive market dynamics.

"I would not be surprised if iron ore retests its lows of around $US40 [a tonne], and possibly even goes through those lows," Mr Norland said. "It could even break below that and hypothetically go down to $US20, which is where it was valued a long time ago.

"There's a lot of potential downside there."

A lower iron ore price typically translates into a lower Aussie. Adding to the weight on the local dollar, Mr Norland said, is that the Australian economy is struggling with its own massive build-up of private debt, mostly in mortgages.

"For most of the last decade debt levels were very, very far below those of Europe and the US, which explains why Australia did not experience a major financial crisis in 2008. Now debt levels have essentially caught up."

Mr Norland believes Australia is "unlikely to experience an acute financial crisis in the near term" thanks to the willingness of the Reserve Bank of Australia to keep rates at what once would have been considered crisis levels, but which today look more normal than unusual.

Running at about 50 per cent of GDP, government debt is "not particularly high by international standards", Mr Norland said. But persistent budget deficits mean the ratio is much higher than it was 10 or 15 years ago. "That also has the potential to weigh on Australia's economic growth."

The good news is that, with the RBA sticking with rates of 1.5 per cent, "an acute financial crisis or collapse in real estate prices is unlikely," Mr Norland said. He labelled the 26-year recession-free record as "incredibly impressive", but said the future looks less impressive.

"I think the future of the Australian economy is to be fairly slow going with low interest rates, possibly buffered by a much, much weaker currency."