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Risks to Australian Dollar in 2017: Chinese Credit Crisis, Commodity Price Reversal

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  • The Pound to Australian Dollar Exchange Rate (11-1-16): 1.6469
  • Australian to US Dollar Exchange Rate: 0.7388
  • Australian to New Zealand Dollar Exchange Rate: 1.0552
  • Euro to Australian Dollar Exchange Rate: 1.4290

The Chinese New Year starts on January 28 and with it the year of the Fire Rooster. 

This will be a critical year for China and those economies that rely heavily on their trading relationship with China; notably Australia.

Apparently, the year of the Fire Rooster does not allow for a "middle way” - a prognostication which does not bode well for tense US-China trade relations.

If US-China trade relations do indeed suffer, as suggested by analysts at Bank of America Merrill Lynch Global Research, it is likely to cause a severe economic slowdown in China, which relies heavily on exports to the United States.

This, combined with China’s precarious debt burden, due to overleveraging during the recent property boom, could tip the country into a credit crisis.

David Cui, Strategist at Bank of America Merrill Lynch Global Research, says the scale of the debt problem is “unprecedented” and that there is now an 80% chance of it leading to a financial crisis in China.

“Historically, over 80% of cases whereby a country grew its private-debt to GDP ratio by over 30% within a five-year period (like China) encountered a financial crisis subsequently,” said Cui in a recent note seen by Pound Sterling Live.

With 42% of Australia’s exports destined for Chinese shores, a recession in China matters for the Aussie economy.

The recent uptick in demand for Aussie commodities such as Iron Ore, Coal and Copper has helped the Australian Dollar by raising Australia's terms of trade – the aggregate Aussie Dollar value ratio of its exports to imports.

But a slowdown in China, which would be expected to hit the property market the most - the market that drives demand for Australia's raw produce - would hurt exports and the Aussie Dollar significantly.

In addition, One of the few areas where the US and China may see eye to eye is energy, and an possible energy deal between the two giants, could have a negative impact on Australia’s growing LNG export industry, further weakening the Aussie and the economy.


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Will China Free its Currency in 2017?

A major headache for the Chinese is Donald Trump.

The President-elect made it a central plank of his campaign that he would end free trade with the Chinese in order to stem the tide of cheap goods coming which he claims are eroding America’s own manufacturing base.

Trump intends to introduce a 45% tariff on Chinese goods and tighten up intellectual property rights protecting US companies from Chinese copyright infringement – to name but a few of the policies he has put forward.

He may also accuse China of being a “currency manipulator”, suggests BoFA’s, Global Economist, Ethan S Harris, which would immediately bring into force a host of trade barriers and also, for example, prevent government procurement.

It has been suggested that in order to avoid this Beijing may retaliate by allowing the Renminbi to float freely.

Harris says:

“China is also unlikely to concede that it is manipulating its currency.

“China is currently fighting to prevent currency weakness, selling its foreign currency reserves to offset private capital flight from the country.

“Some academics in China are suggesting the country should respond to being declared a 'manipulator' by letting the currency float, triggering, even more weakness."

A continued devaluation of the Renminbi would cause major problems for the Chinese economy, the main one being inflation, which would exacerbate the country’s debt problems even further.

Yet, Harris also makes the important point that China does not have a free economy and therefore the debts held at state-owned banks can be rolled over indefinitely unlike those at western banks.

China’s state-backed financial system could therefore be a significant buffer against any crisis which might occur, but it could not necessarily deal with China’s obligations to outside debtors abroad or prevent a currency crisis.

Australian Can't Afford a Weaker Chinese Economy

The third quarter was terrible for the Australian economy after it showed a contraction of -0.5% when economists had forecast the opposite – a 0.5% growth.

Yet, BoFA’s currency team see a modest recovery taking place in Q4, based mainly on improved labour market data, which will come as a relief after Q3.

There is unlikely to be any change in the Reserve Bank of Australia’s (RBA) base lending rate, which will probably remain at 1.5% throughout 2017, according to BoFA.

This comes despite rising commercial interest rates caused by the global rally in yields which began in the Autumn and gained traction after Trump’s victory.

The RBA is unlikely to increase its base interest rates in response as inflation remains subdued and the slowdown in Q3 mean they have to keep base rates low.

The widening disparity between market rates and commercial rates, however, will be positive for Australian banks, which will have a wider scope for making more profit from lending.

Outlook for the Australian Dollar in 2017: The Bank of America View

Back to the Aussie Dollar, and BoFA expectations of RBA inertia is just another headwind, along with the fall in commodities, which is likely to hit AUD in the year ahead.

Their conclusion is that the Aussie will weaken overall against USD, falling to at least 0.70 in 2017, possibly even lower if the commodity slowdown is worst.  sum up their view with the following quote:

BoFA sum up their view with the following quote:

“The AUD had been caught in between the strength of the US dollar and the sharp rally in metal and bulk commodity prices.

“Both moves accelerated following the US election, in anticipation of infrastructure spending in the US.

“While the ongoing unwind in USD longs will support the AUD in the short-term, we believe USD strength will ultimately be the more dominant driver and as argued above we are instead wary of potential downside to bulk commodity prices.”

 

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