Fiscal Policy | FX | Monetary Policy & Inflation
For the first time in 20 years, Australian yields have fallen through Canada’s. In addition, the AUDCAD cross is at its lowest level since the crisis. I expect these trends to persist, which can be expressed as short AUDCAD.
Australia and Canada had a better crisis than most. Both countries had stronger financial sectors than other advanced economies and, as commodities exporters, rode China’s debt reflation. At the same time neither countries could insulate from major central banks easing, which supported growth but saw their real estate prices and household leverage move to the top of global leagues (chart 1)
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For the first time in 20 years, Australian yields have fallen through Canada’s. In addition, the AUD/CAD cross is at its lowest level since the crisis. I expect these trends to persist.
Chart 1: HH Debts and Real Estate Prices
Source: BIS, Bloomberg, Macro Hive
Australia and Canada had a better crisis than most. Both countries had stronger financial sectors than other advanced economies and, as commodities exporters, rode China’s debt reflation. At the same time neither countries could insulate from major central banks easing, which supported growth but saw their real estate prices and household leverage move to the top of global leagues (chart 1)
Table 1: Prudential Tightening in Australia and Canada 2014-2019
Source: IMF, Bank of Canada, APRA
By 2017, the two countries got serious about reining in their real estate markets but went about it differently. Australia implemented the consensus central bank playbook and relied on macroprudential tightening followed by a 75 bp cut in the policy rate in mid-2019 (Table 1 ). By contrast, Canada hiked the policy rate 125 bp during 2017-18 and implemented only limited macroprudential tightening.
Both countries saw a decline in real estate price inflation; that was less pronounced in Canada mainly due to:
• A global backdrop more supportive of Canada: the 2017 oil price recovery lifted growth, employment, and inflation. By contrast, in 2017 Australia was going through the Chinese growth normalisation and the end of the mining investment boom.
• Stronger and more stable Canadian household balance sheets (Chart 1). By contrast, Australian households had started to deleverage ahead of the 2017 prudential tightening.
• Due to rising immigration, since 2015 population growth has accelerated by 50 bp to 1.5% in Canada, a marked acceleration by demographic standards. By contrast, demographic growth has remained constant in Australia.
• Australia’s prudential tightening likely turned out to be more than the RBA had bargained for. The rate cuts likely reflected, in part, concerns over the risk of an adverse feedback loop between household debt and real estate prices. Some of the tighter lending rules have now also been relaxed.
Household deleveraging will take time in both countries but overall will require more policy accommodation in Australia. At the same time, deleveraging has changed the nature of AUD: persistent low yields imply that AUD is unlikely to return to its former carry currency status, and its correlation to global risk appetite is likely to weaken further. In addition, deleveraging means continued high household savings and therefore current account surplus, which will leave AUD less exposed to abrupt tightening of global funding conditions. Going forward, AUD is unlikely to regain its EM-like characteristics and is more likely to behave like a run-of-the-mill G10 currency largely driven by yield differentials.
While markets are pricing in both countries about 35 bp in policy rate cuts by end-year, on balance the RBA appears more likely to cut than the BoC due to:
• Australia’s higher exposure to the coronavirus as a result of its trade linkages with China. By contrast, if global oil demand collapses, Canada would benefit from a likely OPEC production cut.
• While Canada’s inflation has been at the mid-point of the 1-3% target since 2017, Australia’s remains stubbornly below its 2 -3% target.
• Unemployment has been falling faster in Canada and is now below its pre-crisis low.
• The real estate recovery is more advanced, and household balance sheets are more resilient in Canada.
• The BoC is more hawkish. It remained on hold at the 22 January meeting despite expecting a second year of growth below potential in 2020. This was based, it said, on weighing “the risk that inflation could fall short of target against the risk that a lower interest rate path would lead to higher financial vulnerabilities”. By contrast, the RBA is still in household balance sheet repair mode: in the minutes of the December meeting it stated that “the upturn in the housing market was a positive development for the economy in the near term”. In addition, at its 4 February meeting, it stressed that “a further gradual lift in wages growth would be a welcome development”.
These factors suggest that Australia could continue to underperform Canada, which could see more dovish actions by the RBA than the BoC and also relative underperformance in financial markets such as currencies.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)