Mitchell Johnson’s ferocious left-arm fast was awesome to watch, and, we imagine, terrifying to face. On the right wicket his short ball could crumple any batsmen. The recent move of the Australian dollar against the greenback reminds us of his steep, quick bounce.
A predictable track
Some macroeconomic relationships are beautiful in their predictability; such is the relationship between the Australian dollar and commodity prices. As the latter kicked to levels last seen in 2018 (what corona?), the Aussie dollar responded in kind.
Higher commodity prices, higher Aussie $
Source: INet, Obsidian Capital, September 2020
The Australian dollar is perhaps the purest commodity currency in the world. Like their sporting talent (bitter pill), they have rich and diverse natural resources. So, when commodity prices rise in unison, the benefits reach far and wide down under, including a bolstered currency.
The rub of the green
Besides a brief interval spanning 2016 and 2017, the Aussie dollar has given way to the US dollar for the last decade, more so that it should of given what commodity prices have done. A very plausible explanation is that the ‘carry trade’ – the difference in interest rates between the two countries – has been moving in favour of the greenback.
Carry trade has turned in favour of Aussie $
The red line in the chart above is the yield on the Australian 10-year government bond less the yield on the US 10-year Treasury. As it falls, investors prefer the relatively higher yield in the US, which means the greenback appreciates (falling blue line) against the Aussie dollar. The carry trade has now reversed in favour of the Aussie dollar. Things are going their way.
Beneficiaries of a stronger Aussie $
Australian assets are a bit like mustached left-hand bowlers; a bit different and not all that commonly used. But that doesn’t mean they should be ignored completely. The Australian stock exchange (ASX) is quite similar to that of South Africa in that rising commodity prices and a strengthening currency benefit similar sectors.
The most obvious beneficiaries are the likes of BHP Billiton and Rio Tinto because of their link to commodity prices. The banking sector will also benefit; rising commodity prices spark economic activity and borrowing ensues. In the retail space, Woolworths and Wesfarmers are tied to the health of the consumer, who should find themselves with more disposable income as commodity prices rise. CSL, is not strictly a strong Aussie dollar beneficiary, but worth exploring given the promising future of the biotech thematic.