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'Doom Loop' of Debt Threatens to Drag Down Australian Dollar

ForexJan 23, 2019 05:00PM ET
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© Reuters. 'Doom Loop' of Debt Threatens to Drag Down Australian Dollar

(Bloomberg) -- The beleaguered Australian dollar faces a growing threat: an addiction to real estate is creating a debt mountain.

After being the worst-performing developed-nation currency in 2018, the Aussie is set to extend losses this year as rising indebtedness at households and the economy overall make it more likely the Reserve Bank of Australia will cut interest rates, according to both HSBC Holdings Plc (LON:HSBA) and Rabobank. HSBC sees a further 7 percent slide to 66 U.S. cents by year-end, while Rabobank tips 68 cents.

“The RBA just sat there watching the housing bubble grow for the past couple of years,” said Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. “You’re in a doom loop. Now that the Federal Reserve is finally on hold, the RBA can finally talk about cutting again -- and they will.”

Australia’s household debt-to-income ratio has skyrocketed to 189 percent from 67 percent in the 1990s, according to data compiled by the RBA. The increase has gathered pace in recent years as a decline in interest rates encouraged households to take on more borrowing, while an easing of constraints on bank lending increased the funds available, RBA Assistant Governor Michele Bullock said in a speech in September.

Australia’s dollar has already tumbled for five straight quarters -- including a decline of 9.7 percent last year -- as the U.S.-China trade war and signs global growth is slowing has sapped demand for the export-reliant currency.

After ending last year at 70.49 cents, the Aussie briefly slid to 67.41 cents on Jan. 3 in a so-called “flash crash” when a holiday in Japan led to disjointed Asian markets. That was the weakest since the depths of the global financial crisis in March 2009. The currency was at 71.37 cents at 5 p.m. on Wednesday in Sydney.

HSBC is bearish on the Aussie due to the country’s debt binge and also the widening yield discount on Australian bonds compared with U.S. Treasuries, according to David Bloom, global head of foreign-exchange research in London.

“What does concern us about Australia is that their interest rates structure is below that of the U.S., and we would argue that the U.S. is a lower risk profile,” he said, referring to the nation’s debt levels. “You’re getting paid less for the Antipodeans, and you get more risk.”

There’s a 39 percent chance the Aussie will touch 66 cents by year-end, according to data compiled by Bloomberg based on option prices. A year ago, the same projection for December 2019 had a probability of only 14 percent.

‘Keep Cutting’

Rabobank sees the RBA cutting the nation’s benchmark rate by another 100 basis points from the already record-low 1.5 percent to help manage the debt burden, Every said.

“When you have an economy that’s piling on debt the way Australia does, the currency gets well supported because everything looks fine and dandy in this growth bubble,” he said. “And then as soon as you reach the end of the rope, the only thing the RBA can do is cut -- and keep cutting.”

While HSBC and Rabobank are bearish, the broader market is more positive. The Aussie will strengthen to 74 cents by year-end, according to the median estimate of currency forecasters compiled by Bloomberg.

Morgan Stanley (NYSE:MS) says the Aussie will decline to 67 cents in the second quarter before recovering to end the year at 71 cents.

“Markets are currently pricing in about a 50 percent probability of an RBA rate cut over the next 12 months, fairly reflecting the economic weakness,” Morgan Stanley strategists including Hans Redeker in London, wrote in a research note. “Under these dynamics, we see further Australian dollar downside.”

'Doom Loop' of Debt Threatens to Drag Down Australian Dollar
 

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