Societe General Cross Asset Research publish a Special Report titled ‘How to survive the balance of payments crisis,’ and propose investment strategies based on the analysis of external imbalances in 25 developed and 23 emerging countries.
External imbalances
SocGen place special emphasis on external imbalances, saying they have “huge market implications.” Balance of payments dynamics played a huge role in the Eurozone debt crisis and in the turmoil unleashed in the emerging markets after the Fed’s hint to taper off QE3.
SocGen examined the external accounts of a country by looking separately at its (1) current account, and (2) net international investment position. In the words of the analysts, (1) is a ‘flow’ approach, and (2) is a ‘stock’ approach, and both provide different insights into the country’s economics.
It is possible that a country’s current account could be improving but its net IIP remains weak. What matters is an assessment of which has been priced in by the markets.
The situation in Australia and New Zealand
Among the developed countries, significant external imbalances exist in the peripheral nations of the Eurozone and in Australia and New Zealand, and these countries are therefore the most exposed to currency depreciation.
Because Australia and New Zealand have flexible exchange rates the deterioration in the external balances translated into substantial currency depreciation and volatility – 13% versus the USD YTD.
Unlike the Eurozone, where there is evidence that external imbalances are improving, the current account trends show that Australia and New Zealand are still vulnerable.
Combined with an already weak IIP position, there is a case for further weakness in the Aussie dollar, and this is confirmed by SocGen’s proprietary estimates, which say the currency is overvalued by 20% opposite the USD.
China’s ‘structural deceleration’ is another negative for the currency.
Australia and New Zealand will therefore continue to under-perform and are in for a period of currency depreciation and volatility.
Investment recommendation
Trade idea is to short AUD/USD as well as short NZD/USD.
