Australian Stocks Threatened by Strong Currency and a Weak China

NEW YORK ( TheStreet) -- Australia's economic growth reversed a downward spiral late last year, leading iShares MSCI Australia Index ( EWA) to trend higher in 2014, but a stronger exchange-rate and weakness in China could jeopardize further growth. 

The Reserve Bank of Australia said in the minutes for its July meeting on Tuesday that "the exchange rate remained high by historical standards, particularly given the declines in key commodity prices, and was therefore offering less assistance than it otherwise might in achieving balanced growth in the economy."

A stronger Aussie dollar could cause the prices of the country's resource exports to become overly expensive, leading consumers, such as manufacturers in China, to either cut down or substitute investment expenditure elsewhere.

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The run-up in value for the CurrencyShares Australian Dollar Trust (FXA) has taken place over the last year as the central banks of major currencies such as PowerShares DB US Dollar Index Bullish (UUP), CurrencyShares Euro Trust (FXE) and CurrencyShares Japanese Yen Trust (FXY) remain committed to record low benchmark rates, as well as committing to some form of stimulus measure.

This has made the relative attractiveness of the Australian currency greater, even as they too have actively cut rates since 2011.

At this point, policymakers at the RBA do not see the threat of a stronger currency completely dismantling economic growth, and have therefore kept interest rates steady at 2.5%.

Meanwhile, Chinese economic growth numbers release on Wednesday. If Chinese growth declines, it could also mean that demand for Australian resources will slow.

In recent years, China's GDP growth rate has declined to under 8%, as policymakers have attempted to transition the economy from an export-dependent manufacturer to a consumption-driven economy powered by its own internal growth.

Although manufacturing numbers have picked up in 2014, leading investors to bid the prices of First Trust ISE Global Copper Index (CU), and iShares China Large-Cap (FXI) higher, signs of cracks in the Chinese economy could lead to a resumed downtrend of Australian growth, adversely affecting its financial markets.

There has been no catalyst yet to assume that China will suddenly drop below 7% growth and its manufacturing will tumble, but the long-term trend does remain down in both areas.

Ultimately, as resource-rich Australia's equity index trades near yearly highs, risks are mounting both domestically and in China that could present challenges for a sustained move higher.

At the time of publication, the author had no position in any of the funds mentioned.

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This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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