'Doom Loop' of Debt Threatens to Drag Down Australian Dollar
(Bloomberg) -- The beleaguered Australian dollar faces another threat in addition to slowing global growth and the U.S.-China trade war: an addiction to real estate has created a debt mountain.
After being the worst-performing developed-nation currency in 2018, the Aussie is set to extend losses this year as a near-record level of indebtedness at households make it more likely the Reserve Bank of Australia will cut interest rates to support the economy, according to strategists at HSBC Holdings Plc 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 fueled by low interest rates and an easing of constraints on bank lending, according to data compiled by the RBA.
While the debt ratio edged down in the third quarter as the government sought to restrain lending, it is still almost double the average since the series started in 1977, raising concern over a sliding property market and its impact on the economy. House prices slipped an average 4.8 percent nationwide last year.
Australia’s dollar has already tumbled for five straight quarters -- including a decline of 9.7 percent last year. After ending 2019 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, the weakest since the global financial crisis in March 2009. The currency was at 70.98 cents in early London trading on Thursday.
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 Australia’s debt levels. “You’re getting paid less for the Antipodeans, and you get more risk.”
There’s a 42 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.
Rabobank sees the RBA reducing 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 both downbeat on the Aussie, the broader market remains positive. The Aussie will strengthen to 74 cents by year-end, according to the median estimate of currency forecasters compiled by Bloomberg.
Morgan Stanley says the Aussie will decline to 67 cents in the second quarter before recovering to end the year at 71.
“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.”
©2019 Bloomberg L.P.