Aussie dollar relatively safe | David Taylor | Finance News Network

Aussie dollar relatively safe

by David Taylor

 

There's been some talk recently that the Aussie dollar may have reached its peak - that it's over valued and due for a sharp correction. To assess the validity of these claims we need to look at why and how the dollar has held above parity.

 

There's really one force that pushes up the price of Aussie dollars. It's demand. That demand can stem from a perceived capital gain to be made by holding the currency itself, or wanting to hold the currency in order to purchase goods and services that can only be purchased using the local currency. Example of the former would be making money by speculating the Aussie dollar will push higher and taking a "long position". The later would involve a foreign company buying Aussie dollars in order to purchase coal from one of our resources companies.

 

Demand can stem from another source as well - interest rates. This is in fact a key reason for the Aussie dollar being as elevated as it is at present. Simply put, if you borrow money in a low interest rate environment (the US), and place it in a country with higher interest rates (Australia), your interest margin is going to be profitable. The cash rate in the US is practically zero. The cash rate in Australia is 4.75 per cent. Clearly there's money to be made.

 

What some analysts and commentators are suggesting now is that this is about to unravel. The short answer is that it's not. The US are not about to start raising rates, and China is not going to implode on us in the short or even medium term (longer term is another story).

 

What we could see, however, is a lot of speculative money coming out of the market in the short term as market participants become concerned about the sustainability of the Aussie's recent push. All it would take is one or two significant international hedge funds to unwind their positions and you could see a domino effect. The Chinese Premier also flagged this week that they are headed for growth of around 7 or 8 per cent in the medium term - which could most definitely take some heat out of the dollar. But there's simply no fundamental reason to see a sustained collapse in the local unit.

 

By all means watch out for a technical pull-back, or some volatility on the back of speculative panic attacks, but the Aussie seems fairly well supported and safe north of around 95 US cents at this point.

 

David Taylor

Disclaimer

The content in my blog is non advisory, please do not interpret this as advice in any way shape or form. These are just my thoughts and nothing I say should be acted upon.