Aussie iron ore shows signs of topping out

Bloomberg

This may be as good as it gets for the Australian dollar, the best-performing Group-of-10 currency this year. The drivers behind the Aussie’s two-month rally are being eroded as iron ore shows signs of topping out and Australia’s yield advantage over the US shrinks. The currency is almost 5 percent overvalued based on regression analysis linking it with interest-rate spreads and prices for the country’s most valuable export.
The Aussie has a fair value of 73 US cents, based on data for the past five years, compared with the level of 76.57 cents at 12:13 p.m. in Sydney on Thursday. Regression analysis is a statistical tool for calculating the relationship between different variables.
Iron ore prices have fallen almost 4 percent since reaching a more than two-year high last week. Before that decline, the commodity had surged 70 percent from the end of June to as much as $94.86 a metric ton, contributing to a record trade surplus in December.
Trade data released Thursday showed Australia’s exports slid 3 percent in January, while the trade surplus was a smaller-than-forecast A$1.3 billion ($996 million).
Surging demand from China, the world’s biggest consumer of iron ore, had driven up prices and raised questions over the sustainability of the rally. The Asian nation’s top economic planner is investigating whether speculation has distorted commodity futures prices, people with knowledge of the matter said last month.
“I do think that commodity prices are going to come back off again,” Reserve Bank of Australia Governor Philip Lowe told a parliamentary panel last Friday. “We shouldn’t start to think that the iron ore price is going to stay around $90.”
Interest rates in the US and Australia are on course to converge at 1.5 percent with the Federal Reserve signaling it will raise its benchmark three times this year, while its Australian counterpart is expected to keep borrowing costs at a record low.
Lowe, who took the helm in September, said last week the current setting of 1.5 percent is consistent with achieving sustainable growth. The odds of the Fed tightening at its March 14-15 meeting jumped above 50 percent this week as policy makers said they will seriously consider acting this month.
The diverging outlook for central bank policy narrowed the spread between Australian and US two-year interest-rate swaps to 34 basis points this week, the least since May 2001 and down from as much as 131 basis points in February 2016.
Lowe said last month he would prefer to see the Australian dollar weaker rather than stronger, and it “would be better if it were lower still.” Traders, take note.