- Despite poor data and comments from the RBA, short-term AUD pessimism seems overdone
- The Aussie has been a big beneficiary of Chinese growth, this is clear from looking at Chinese debt data
- As China is now one of the world's most indebted countries, the longer term outlook for the Aussie is cloudy
It’s easy to be pessimistic towards the Australian dollar these days. Recent economic data points to substantial weakness in household finances, with the latest retail sales figures widely missing estimates. Looking more deeply into the numbers shows a particular weakness in the café and restaurant segment. The visual image of Australian households cooking at home in order to save money (and pay down their mortgages) is concerning. Unsurprisingly, the currency fell on the news. The currency has faced further headwinds from Reserve Bank of Australia board member Harper suggesting that “if you start to lose that [growth] momentum, that might be the basis of some sort of policy action”. With markets primed for talk of hiking interest rates on rising growth, the suggestion of falling interest rates on weak growth is even more concerning.
With the Communist Party of China’s National Congress slated to begin later this month, economic surprises from Australia’s largest trading partner are likely to be limited. Following the recent ‘Golden Week’ holidays, the offshore Chinese yuan is now rebounding against the dollar, having fallen into oversold conditions in early October. So far, the Aussie has failed to follow suit, and is instead weakening again today on poor Chinese PMI figures. This morning, Caixin Services PMI figures registered at 50.6, vs. 52.7 previously. Looking at AUD/USD, the pair now looks oversold at 0.7750, and is due for at least a short-term rebound. This is shown in the graph comparing AUD/USD and USD/CNH (inversed) below:
Offshore yuan turning ahead of the Australian dollar
Short term weakness overdone, but long term remains shaky
In the longer run, China’s economy looks set to slow down as debt growth decelerates in rate-of-change terms. While debt growth in China’s non-financial private sector has been as high as 15% in recent years, the latest figures from the Bank for International Settlements shows Q1 2017 year-over-year debt growth at less than 5%. This is shown below:
Slowing debt growth means lower demand for Australian exports
Looking at the graph of debt growth above, the strength of the Australian dollar has been strongly correlated to Chinese debt growth in recent history. Given that much of China’s recent debt has been allocated towards infrastructure and industrial investments, the country has become the largest buyer of Australian commodity exports. Unsurprisingly, the Australian dollar has benefited from Chinese investment activity. The currency most recently peaked in 2012, when Chinese debt growth was running above 15% per year. Since then, the Aussie made its most recent low in Q4 2016 (when Chinese debt growth was just 0.8%). The currency has since rebounded in Q1 2017 and has strengthened for most of the year. Unfortunately, more recent data regarding Chinese debt is not currently available.
An aging debt boom comes to an end, despite a strong 2017
As China’s total private sector debt-to-GDP is very high (210.8% in Q1 2017 according to BIS figures), especially for a developing country, the economy is unlikely to withstand 10% rates of debt growth in the near future. This year may have been the exception, given the importance of economic stability ahead of the Communist Party’s 19th Congress. Looking into 2018 and beyond, betting on continued debt growth and Australian dollar strength is much tougher. While the currency is due for a short-term rebound today, the long-term outlook is cloudy.