Is Surging Aussie Dollar Out of Whack With Fundamentals?

Hot money flows into the Australian dollar, which got a further boost on Thursday from a surprise increase in job numbers for July, has some market watchers questioning whether the currency’s rise is out of “whack” with economic fundamentals. But one strategist argues that the Aussie’s performance is not surprising from past trends.


Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital Investors says calls for the Reserve Bank of Australia (RBA) to intervene to stem the Aussie’s rise on the basis that it’s being boosted by capital inflows are not justified.

“The recent strength in the Australian dollar is not particularly unusual and is certainly not extreme enough to warrant any direct intervention in foreign exchange markets by the RBA to limit its value,” Oliver said in a note on Thursday.

Economists have been concerned that the currency is being driven higher by temporary factors like investors seeking safe havens fleeing the euro and the U.S. dollar and central banks diversifying their reserves.

The RBA, which kept interest rates on hold earlier this week, warned that the Aussie dollar has remained high despite a decline in fundamentals like the country’s terms of trade — which measures the ratio of export prices to import prices — and a weaker global outlook.

The Australian currency has risen 9 percent since June and hit a four-and-half-month high of $1.0606 on Thursday, while the terms of trade have declined for the past three quarters, ending the June quarter down 1.3 percent, compared to the previous three months.

While Oliver admits that temporary “hot money” has played a role in the Aussie’s recent strength, he says the commodity currency move in the opposite direction from the terms of trade is “not that unusual.”

“The Australian dollar and the terms of trade often moved in different directions from year to year in the 1980s and 1990s,” Oliver said.

Short term swings in the Australian dollar are also highly correlated to the performance of the U.S. share market, according to Oliver, who says the currency has become part of “risk on/risk off” trading in recent years.

“The roughly 9 percent upswing in the Australian dollar since early June is entirely consistent with a roughly 10 percent upswing in share markets [S&P 500] since then,” Oliver said. “This phenomenon can explain a big part of why the Australian dollar has appeared to diverge from fundamentals."

Instead of intervening in the foreign exchange markets, a better approach for the RBA to limit the Aussie’s value would be to continue to lower interest rates, Oliver says.

The RBA kept the official interest rate unchanged at 3.5 percent earlier this week for a second month in a row, following consecutive rate cuts in May and June that bought the cash rate to its lowest level since the end of 2009.

- By CNBC's Rajeshni Naidu-Ghelani.