Aussie dollar surprises market

The Australian dollar’s (AUD) strong rally in recent weeks has caught the market by surprise and signs show that it could push higher – possibly even hitting US$0.85. That’s a big jump compared to US$0.80 today and just US$0.74 back at the start of June.

The strength of the currency reflects a few main factors:

  • First, the rally of the Canadian Dollar and its effect on other currencies, which came after a change to the country’s interest rate.
  • Second, increasing chances of a rate rise in Australia on the back of economic strength. Saying that, we don’t expect the Reserve Bank of Australia (RBA) to hike rates soon as the AUD rally has done that for them. The market is now pricing in a 70% chance of a rate hike by the middle of next year – up from just 20% a month ago.
  • Finally, global growth continues to be resilient which supports the China story. China has released some unexpectedly upbeat data, including Q2 GDP figures, which has prompted an increase in the price of industrial metals.

Even with weaker-than-expected inflation numbers in Australia the dollar has still been strong. This shows that the rally is more about the strength of the economy and China, rather than interest rate policy.

How long the Australian Dollar will be strong for remains to be seen. The Chinese economy may lose some momentum in the second half of the year, which could affect our currency. That said, the market expected China to fall off a cliff during 2016 but it never eventuated. 

At the end of the day, it will be the strength of industrial commodities like Oil and Iron Ore which will drive the direction of the Australian dollar.

Oil prices continue to rally

Speaking of oil, the price continues to rally driven by large falls in US crude and gasoline stock, as well as a pick-up in demand. The weakness of the US Dollar against major currencies is also aiding the oil price.

Oil stock levels are expected to continue to decline over the rest of the year for three main reasons:

  1. There is accelerating demand for oil on the back of improved global growth;
  2. OPEC members are abiding by their quotas for oil production; and
  3. US oil production shows little sign of accelerating.

Current geo-political risks including issues in Venezuela, the proxy war in Yemen (between Iran & Saudi Arabia) and the problem of North Korea could also add fuel to the price of oil.

Markets cautious as tech stocks retreat

Equity markets will remain on a cautious footing as technology stocks retreat and US wage growth softens. The rejection of the US Government’s plans to repeal Obamacare is also having an impact.

The latest sell-off in tech stocks has made for dramatic headlines, comparable with the dot com collapse. However, unlike back then, there are few signs that technology companies are dramatically overvalued. The key difference is that the recent strength appears to be justified by improved earnings – both actual and projected. In contrast, the hype of the dot com era was based on projected earnings alone.

We don’t believe that there is a bubble in the technology sector, or that much larger falls are on their way. Rather, we think the market just hasn’t yet appreciated the rise of AI and mobile technology.

Emerging Markets

Finally, a word on emerging market equities which have continued to rise recently (the MSCI EM Index has climbed by 9% during the last 3 months). Despite the gains, valuation levels still appear quite low relative to developed market equities. Further rises in valuations and earnings should help emerging market equities to keep on climbing, albeit not at the pace they have done so far in 2017.

 

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