Morgan Stanley on the Australian dollar … looks vulnerable (sell AUD/JPY)
This from MS weekly look at currencies, for late last week. A quick comment on the AUD and a recommendation
- Declining yield and interest rate differentials stand in contrast with its increasing foreign funding needs. Until now, Australia has bridged this gap by increasing equity-related inflows. That strategy worked in times of bullish risk appetite. But interest rate differentials are smaller and Australian asset valuations are increasingly dependent on foreign flows. As a result, AUD may decline faster than previously when risk appetite diminishes.
- RBA moving towards rate neutrality has been a game-changer for AUD
- We see evidence that AUD is increasingly used as a funding currency
- Australian economic conditions have deteriorated
- high household debt reduces workers' appetite to aggressively demand higher wages. This low-inflation dynamic may intensify as real estate prices have started to fall, reducing net household wealth
On the AUD:
- We recommend selling AUDJPY
- The risk to this trade is central banks globally turning dovish as global growth moderates, but develops a synchronized pattern. In this case, Japan may continue shifting funds abroad and Australia may find it easy to attract equity inflows. Nonetheless, we regard the probability of such an outcome as minimal. In the absence of rising factor productivity growth, accelerating G-10 wage inflation either suggests higher inflation or lower corporate profits, not boding well for the global risk outlook.