It seemed like a sure-fire bet a few weeks ago: Abandon the yen and euro for the high-yielding Australian dollar. Yet these positions have been blown out of the water this week, proving that interest rate differentials are not everything when choosing a winner in the currency market. Turning bearish on the yen after the Bank of Japan's (BOJ) shock adoption of negative interest rates, and selling euro as European yields sank deeper into negative territory were popular. Buying the Aussie dollar was a natural fit, given Australia's relatively plump and steady 2.0 percent cash rate.
But the Aussie is now staring at its 2012 low against the yen, having shed nearly six yen in as many sessions. The euro is flirting with A$1.6100, nearly 10 Aussie cents higher in just two weeks. At the heart of these counterintuitive moves are current account surpluses - a currency factor that is often glossed over, but which comes into its own when combined with heightened risk aversion.
"Current accounts are a more significant, long-run driver of exchange rates than are interest rate differentials," said Richard Grace, chief currency and rates strategist at Commonwealth Bank of Australia. "They are slow-moving factors behind the scenes and are not as in-your-face as an interest rate change or an interest rate differential which is moving minute by minute."
At last count, the euro zone is running an annualised surplus of around 360 billion euros ($407 billion) while Japan has a roughly 17 trillion yen ($148 billion) surplus. In contrast, Australia and the United States are in deficit. Countries boasting large surpluses earn more money from abroad than they pay out, which, in theory, should push their currencies higher over time.
Huge monetary stimulus by the BOJ and European Central Bank (ECB) short-circuited this trend in recent times, however, but this year's turmoil in global markets has brought current account positions back into focus. The market turmoil - especially sharp falls in European and Japanese stocks - makes it likely that European and Japanese investors might liquidate foreign assets to cover losses suffered at home.
That is especially significant in Japan's case because of its status as the world's largest creditor nation with its net holdings of around $3 trillion. That is a major reason the yen has recovered from its sell-off after the BOJ took rates negative. The euro has likewise surged even as the ECB president all but promised further easing.
To be sure, the BOJ and ECB will not want to see their currencies strengthening on a sustained basis at a time when global headwinds have picked up again. But for now, analysts said the current account effect could persist for a while. For the Aussie, which as a commodity currency is often sold in times of heightened market stress and global growth worries, the outlook has darkened. "In terms of risk aversion, the Aussie is usually the safest sell trade. There is further downside scope for the Aussie if you're bearish on global appetite in general," said Sean Callow, senior currency strategist at Westpac.
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