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A More Stable Australian Dollar Going Forward as Current Account Deficit Narrows

Australian current account to improve and lend support to the Aussie Dollar

The Current Account - one of the more complicated concepts of global foreign exchange for your everyday reader to grasp.

But, it is an incredibly important concept and for those watching the Australian Dollar important new research on the Australia's current account deficit will prove incredibly important.

Australia is a country that has for a long time run a current account deficit and this has exposed the AUD to volatility in that time.

But, this could be about to change.

“In Australia we are now forecasting a sustained improvement in the current account – with historical deficits giving way to broad balance by Q1 2017,” says Daniel Been, Head of FX Research at ANZ Bank.

The implications of this are huge argues Been:

“Our analysis suggests that the AUD will likely become less sensitive to the narrowing in rate spreads that we are forecasting, risk appetite could decline in importance as a driver of the AUD and, in general, the AUD could trade with more resilience to the ebbs and flows of global FX markets.”

What is the Current Account

Compelling stuff from ANZ then. But, what is the current account and why does it matter?

It is defined as the sum of the balance of trade (goods and services exports less imports), net income from abroad and net current transfers.

A positive current account balance indicates that the nation is a net lender to the rest of the world

Importantly from a currency angle, countries with a notable current account deficit often come under increased investor scrutiny during periods of heightened uncertainty and the currency is therefore exposed to notable volatility.

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Australia’s Current Account Deficit to Narrow

Australia, like the UK, has long maintained a current account deficit as it tends to import more than it exports.

It is ANZ’s suggestion that because of this deficit the Australian Dollar has traded with a relative degree of volatility over recent years.

But, the country’s current account position has been steadily improving over the course of the past year.

The most recent data showing the current account deficit was less than 1% of GDP in Q4; its lowest level since at least the floating of the AUD in 1983!

Australian Current Account Position improves“Our forecasts expect this improvement to continue such that the current account will be broadly balanced by Q1 2017, and this will remain the case across the forecast horizon. This is a rare occurrence,” says Been.

What Does this Mean for the Australian Dollar?

In short, we can gain more confidence in the Australian Dollar’s ability to sustain itself.

Current account deficits are financed by foreigners buying the securities (ie stocks and bonds) and companies (ie FDI) of a given nation.

“A smaller current account deficit will mean that Australia is less reliant on external funding and thus should be less vulnerable to sudden shifts in investor sentiment,” says Been. “This should potentially be reflected in a lower volatility structure for the AUD and a lower sensitivity of the AUD to the rate spread (the price of attracting capital).

ANZ used Canada’s recent history as the basis of a case-study to understand how the Australian Dollar could behave under a current account surplus scenario.

Canada experienced a sharp lift in its terms of trade in the early 2000s which translated into a sustained current account surplus.

Been and his team found:

1) That the currency tends to be less dependent on global factors, such as the direction of the broad USD or risk appetite, and shows some more sustainable strength.

2) Volatility in the currency was skewed higher when the current account was in deficit.

3) When the current account is negative there is certainly a strong positive relationship with the rate spread. However, as the current account turns positive, that relationship becomes more ambiguous.

“The experience of Canada, while more positive than what we anticipate for Australia, is still instructive in understanding what could unfold,” says Been.

ANZ’s analysis suggests that the AUD could become less sensitive to the narrowing in rate spreads than they are forecasting, that risk appetite may decline in importance as a driver of the AUD and that in general the AUD could trade with more resilience to the ebbs and flows of global FX markets.