NEW YORK (TheStreet) -- The Australian dollar has steadily challenged the U.S. dollar in the past year, encouraging views that the former has become a safe-haven currency.
The Australian dollar has soared 12.2% over its U.S. peer in the past year -- even more so than the euro, which has risen 5.3% in the past 12 months over the greenback as the European Central Bank leaves the door open for more interest rate hikes.
Still, UBS Head of Foreign Exchange Strategy & Precious Metals, Mansoor Mohi-uddin, cautioned this week that the Australian dollar hasn't become a safe-haven currency.
Mohi-uddin said the Australian dollar's almost three-decade high against the dollar is driven by three factors.
The first is it has a very high yield for a major currency. The Reserve Bank of Australia, the country's central bank, has an interest rate of 4.75%. "Many clients, particularly at Asia, want to hold the Australian dollar as a high-yielding asset," said Mohi-uddin.
"The second reason is simply positioning," the currency strategist explained. Many investors in the markets were expecting the Australian dollar to stop rising. When the earthquake hit Japan, the Australian dollar did fall. UBS clients sold on the currency's way down.
But the Australian dollar has since rallied again, forcing clients who were short the currency to cut their positions. "We call this the pain trade," said Mohi-uddin.
Mohi-uddin points out that the Australian dollar's drop at the height of the earthquake disaster in Japan and on Japan's recent elevation of radiation warning levels post-earthquake is an example of why it isn't a safe-haven currency.
The Australian dollar fell to a two-week low against the yen on March 11, dipping to JPY 81.96, before tumbling 0.2% to JPY 82.91 when the 9.0 magnitude was unleashed on Japan.
On Tuesday, the Australian dollar fell 1.8% to JPY 87.202, the day Japan raised the severity level of its post-earthquake nuclear crisis to that on par with the 1986 Chernobyl disaster.
"It's clear though, it's not a safe-haven reason why people are buying the currency ... when we had news that in Japan the nuclear reactor situation had been upgraded to the worst possible rating. The Australian dollar then fell, so it shows you that investors are buying this currency when they're seeking risk, rather than when they're risk averse. When they're risk averse, they sell it," Mohi-uddin explained.
The third reason for the currency's rally has been more broad-based, the strategist told
during a talk at UBS's Manhattan headquarters this week. Central banks around the world have been increasing their exposure to the Australian and Canadian dollars. "It's been a very important trend in the markets over the last few years."
The currency strategist predicts that the Australian dollar's rally against its U.S. counterpart will dull after when the Federal Reserve's second round of quantitative easing ends in June. This, despite a prevailing view, supported by dovish comments from key policymakers citing the fragility of the economy, that U.S. rates will stay very low after QE2 as countries such as Australia, Turkey, South Africa and Brazil keep their interest rates high.
Mohi-uddin says many of his clients are short dollars using leverage, so as soon as U.S. money market rates begin to rise with the end of QE2, they will likely cut their positions; at that point, it will become much more expensive to hold a leveraged short dollar position.
"So it doesn't matter if the interest rate differential is wide, which would favor you being short dollars," Mohi-uddin said. If you're leveraged, if you borrow say three times, five times the amount of your capital -- as soon as your interest rate costs go up, you have to cut those positions quickly. That then will help the dollar rally again."
The U.S. dollar was trading sideways at AUD 0.9521 Thursday morning. The
PowerShares DB US Dollar Index Bullish
PowerShares DB US Dollar Index Bearish
were also trading sideways, at $21.48 and $28.51, respectively.
-- Written by Andrea Tse in New York.
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