Interesting paper by MSCI Research came out eaarlier in the week about hedging…click here. Its US centric with some interesting analysis and but the basic conclusion should apply to any country. i.e. basically over the long run currencies revert to the mean resulting in no real difference, but over the shorter term currency effects can have quite an impact. However, for this US study, hedging “generally reduces volatility most of the time for most currencies at all horizons”…BTW…this study was analysing equity returns (all global fixed interest should be hedged in aportfolio context assuming you are using it for income whereby currency effects add way to much volatility for a “defensive asset”).
The US Dollar is at record lows thanks to the Fed’s announcement to print some money, the Renminbi (Yuan) is pegged to the US Dollar and the US Government is putting lots of pressure on the Chinese to appreciate it…surely the long term bet of the month is to buy the Yuan as there appears to be so much more upside potential than downside risk.
Please note, this is not a recommendation to any reader to buy the Yuan just my simple personal thoughts on its upside versus downside potential.
Normally I try and produce the chart before the RBA’s decision but was a little slow this time but it is a little intersting to see the market’s reaction to the RBA’s decision to increase the cash rate to 4.75% and its shown in the chart above…an increase in yields across the all maturities although not too much for the 3 month T-Note.
Anyway, I can imagine Steve Kean will be smiling as one of the likely impacts of this rate rise will be further declines in residential property prices across Australia. Personally, I am currently waiting on my mortgage lender to get back to me with an indication of my borrowing capacity….I guess with this rate rise he might come back with a pretty low number…oh well, no hurry for me as I partilaly agree that property prices will go lower or at best sideways for a long time yet.
Not surprisingly, the Australian sharemarket dropped a little bit as soon as the RBA’s announcement was made (as valuations reduce with higher interest rate) but then increased around 15points to the end of the day…not much of a movement but I guess the RBA’s concerns are about higher inflation resulting from stronger private spending which should be a positive for the sharemarket. Employment is strong and likely to be looking stronger in the short term so this move makes sense if that’s the case.
Not surprisingly the rate rise has seen the Aussie dollar incerase sharply and is again flirting with USD parity. It immediately jumped 1cent after the announcement and has been sitting on 0.998USD since.
Whilst the RBA is concerned about local inflation, with this strong dollar I tend to think a lot of our dollars will be spent overseas and/or reducing our personal debt and irrespective of our spending patterns, with deflationary concerns continuing in the US, Japan, and Europe my gut feel is that this move may be a tad premature.
All this talk about Australian Dollar and US Dollar parity got me thinking about the behaviour of the Aussie relative to other assets, namely the sharemarket. The above chart shows that, with the exception of the first half of 2008 when the the sharemarket was a little more forward thinking than the RBA, there has been a fairly strong correlation between the sharemarket performance and the Aussie dollar. Basically both of these ‘plays’ are risk trades and the correlation over the last two and a half years has been very high.
So whilst the RBA and the bond market is currently talking up a rate rise which will most likely bring sufficient AUD strength to bring parity with the US Dollar, it is the global willingness to accept risk that will ultimately determine whether parity holds or not. For example, if global sharemarkets start to plummet because the Greek Crisis has turned into a Greek and Irish Crisis so too will the Aussie dollar decline…irrespective of the RBA’s talk of inflation and interest rate rises.
