This post will discuss Chinese growth, the recent decline in base metals’ prices, and the outlook for the Australian and New Zealand Dollars.
The story of China’s “hard landing” is an easy sell: excess liquidity in the Chinese financial system, thanks to the People Bank of China’s massive expansionary monetary policy over the past few years, will stoke inflation; and then the PBoC will be forced to tighten policy too quickly, ensuring what is known as a liquidity trap, choking off growth far too rapidly.
But the naysayers have been proven wrong thus far. The 4Q’12 annualized Chinese GDP figure came in at +7.9% from 7.6% in the 3Q’12, and growth is expected to have a floor near +7.5%, according to estimates provided to Bloomberg News back in December. As always, we look to the PMI Manufacturing index, as well as base metals’ prices (the literal building blocks of society come from base metals), as forward indicator of Chinese growth prospects. The signs aren’t welcoming going forward.
Iron Ore is a strong indicator of future growth prospects because it is required in the process to make steel; and steel, of course, is the preferred material to construct larger buildings, making it a popular resource in emerging market economies like China. Over the past several months, Iron Ore prices rallied quickly; but in February, prices have started to pull back as the Chinese PMI Manufacturing index has eased. Not only does this mean China could see slower growth going into mid-2013, but so too could Australia and New Zealand, as two regional economies for which China is their number one trading partner.
On their own, Australia and New Zealand are very different economies and countries. But in the broad context of global finance, their currencies are very alike – both are considered to be high beta commodity currencies, given the higher interest rates offered by their respective central banks. Considering where the market is pricing in rate expectations for the Australian Dollar over the next 12-months, it appears that the Australian Dollar is below fair value; on the other hand, the New Zealand Dollar is trading slightly rich relative to its interest rate expectations.
In the context of Chinese growth, Australia is more likely to be directly affected than New Zealand, so Iron Ore, Australia’s top export, serves as a strong proxy for growth hopes for China. At this point in time, given the signal in not just Iron Ore, but Copper as well (which has fallen back very sharply the past several weeks), it appears that the Australian and New Zealand Dollars could be poised for continued weakness throughout the 1H’13, before turning around and strengthening in the 2H’13, especially against the European currencies. The AUDUSD could decline into 0.9800 before rebounding back towards 1.0600, while the NZDUSD could fall towards 0.8000 before a move back to recent highs near 0.8500.