In the last week or two, the Australian dollar has lost more than 10% of its value. At one stage today, it had lost 3% from peak to trough.
No-one really knows why, except for global uncertainty about future commodities (minerals) pricing.
Down and down it goes, where it stops, nobody knows.
Good for exports, bad for imported computer parts prices.
Ordinarily, currency values are largely affected by interest rate differentials. But what you have in the case of the AUD is largely to due with the unwinding of the AUDJPY, and other YEN related carry trades.
In a carry trade, you borrow in a low yielding currency (like the YEN) and then invest those funds in a high yielding currency. (you pocket the difference between the two rates -- that's the carry; you want positive carry). Carry trades like calm stable markets. When carry trades grow in size, they can start to weigh on the funding currency and boost the investing end. (look at the large, gradual appreciation of AUD last yr). They're nice and all when they work, but when the sh*t hits the fan, everyone piles out at once -- many of the participants are highly leveraged, so small swings in the currencies can have drastic results to the bottom line.
An example:
- pretend you got into the game late, say, Oct 2009
- you borrow mega amounts of Yen at a low rate of, say, 0.2% per annum
- you sell your YEN and buy AUD at a rate of AUDJPY 78
- you bought AUD because you, for the time being, believe that
* the Aussie economy is robust and recovering
* and being a commodity producer, Aussie economy will benefit from Asian (read China) need for commodities, and
* being a recovering economy, and with a growing housing bubble, the chance for Aussie interest rate increases is high (and that these increases will in turn lead to AUD appreciation)
- so you plow your borrowed funds into <insert high yielding risky Aussie dollar denominated asset of choice here>
For awhile every goes swimmingly well. In fact, as more greater fools jump on board this very same trade, the more its success becomes self fulfilling:
- more selling of YEN drives YEN lower; more buying of AUD drives AUD higher
- Aus economy doing well; interest rates start going up .. further boosts AUD
- China/Asia buy commodities .. which Aus is happy to sell to them
- your <insert high yielding risky Aussie dollar denominated asset of choice here> investment appreciates
- you're making a killing/lots of positive carry (both in terms of (a) the difference btw the rate of yield you're getting on your investment and the interest you have to pay on the borrowed funds and (b) because you've probably leveraged on the trade to the hilt and (c) the currency appreciation you've experienced ... AUDJPY now trading at, say, 86.)
Then SHTF
- Eur starts blowing up and uncertainty leads to capital flights to safety .. JPY is a beneficiary of this flight
- crazy Aussie tax on miners
- whole world starts noticing that Chinese mkts are now down 20% ...uh oh, maybe China won't save us all
- uncertainty! uncertainty! its every where! aaaahhhhhhh!.... etc etc...
- and suddenly every leveraged fool is faced with the distinct possibility that their once wonderfully profitable carry will turn negative in a hurry.
- queue the
Three Stooges Syndrome ... if this trade really has become popular, then, as everyone rushes to the exits all at once, the unwinding of the carry trades creates large opposite distorting effects -- selling of Aussie risky assets and dollars and buying of YEN ... soon enough, AUDJPY is sitting at 72.
