Dollar's Year Of Extreme And Unprecedented Volatility

Sydney Morning Herald

Thursday January 1, 2009

Vanessa O'Shaughnessy

"IT MAKES the bursting of the tech bubble look like a teddy bears' picnic," says Westpac's Sean Callow, trying to describe the year in currency markets.

As a senior strategist, Mr Callow has watched the Australian dollar head towards parity with the US dollar, only to plunge back down to near US60c. All in the space of a few months.

There were several reasons why, at the start of the year, the Aussie looked invincible. The US dollar was weak and commodity prices were on the rise.

At the same time the Reserve Bank was raising interest rates, taking them to 7.25 per cent, their highest since mid-1996.

And because other central banks were cutting rates, that attracted yield-hungry investors willing to take a punt on the Aussie for a higher return.

Then, in July, it all started disintegrating. "We were woken by a bucket of cold water on our heads," Mr Callow says.

John Kyriakopoulos, head of currency strategy at nabCapital, says volatility was extreme and unprecedented.

The Aussie traded in its widest range ever over just three months - from above US98c to near US60c. October was particularly volatile, claiming the 10 largest daily percentage changes in the $US/$A exchange rate since the Aussie was floated in the early 1980s.

This was despite action from the Reserve Bank which bought just over $3 billion in October, in an attempt to smooth markets. On three occasions during October, the Aussie fell US7c in a matter of hours. And the weakness was not just against the US dollar. Japanese investors who had so willingly engaged in the carry trade also got cold feet. That sent the Aussie into a tailspin against the yen.

"The carry trade was a favourite strategy that relied on low volatility, leverage and wide interest rate spreads," TD Securities' chief currency strategist, Shaun Osborne, says.

But those three factors started moving against investors after September. "The most gob- smacking move of the year was probably the 20 per cent or so fall in the $A/yen in the space of just three days in early October," Mr Osborne says.

On October 6, the Aussie was buying up to Y81.25. By October 8, it was Y63.75. Such falls were abrupt and unsettling. And they affected individuals and companies alike.

Travellers overseas had their purchasing power slashed. Others were forced to reconsider trips. And exporters and importers had to rapidly adjust to a new reality.

"Importers who had enjoyed cheaper importing costs . . . had the rug pulled from under them," OzForex's manager of corporate business, Jim Vrondas, says.

"Costs increased by more than 30 per cent at a time when retail spending has slowed, and with fears of a recession in Australia during 2009 the near term outlook is bleak."

For exporters, the situation was reversed. The lower dollar meant their income increased almost overnight.

All of this took place in an environment where governments and central banks were scrambling to hold the world financial order together.

Credit markets were, and remain, frozen. Equity markets were, and remain, highly volatile. And tolerance for risk has all but disappeared.

Forecasts for where the dollar will be in six or 12 months are now more conservative.

"Risks to global growth remain to the downside," RBC Capital Markets's senior currency strategist, Sue Trinh, says.

She expects the Aussie to bottom near US55c in mid-2009, before recovering to about US62c by the end of the year .

Westpac forecasts levels nearer US69c, while nabCapital expects the dollar to stage a recovery, rising to about US76c within the year. OzForex predicts a similar outcome.

Their strategists acknowledge the slowdown in global growth and the effect this is likely to have on Australia. They, like most economists, also predict a rise in unemployment in Australia - and a 50-50 chance of a mild recession.

© 2009 Sydney Morning Herald

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