The Strongest Dollar Since December 1996

The Australian dollar surged to the strongest since 1996 as traders increased bets the central bank will raise interest rates from a six-year high.

The currency climbed for a fifth day against the U.S. dollar as an Australian index of leading economic indicators rose in January, backing the central bank's case to boost borrowing costs. A rate increase may encourage investors to put on so-called carry trades, where they buy the nation's higher-yielding assets with money borrowed cheaply in Japan.

``We'll see more demand on the back of an expected rate hike,'' said Steve Schuster, head of foreign-exchange trading Australia & New Zealand Banking Group Ltd. in Melbourne. The currency ``will continue to do well.''

Australia's dollar touched 80.41 U.S. cents before trading at 80.16 cents as of 5:30 p.m. in Sydney from 80.03 yesterday in Asia. It pared gains after Treasurer Peter Costello said the currency's appreciation is hurting exporters.

The currency has risen 1.5 percent since Reserve Bank of Australia Assistant Governor Malcolm Edey March 16 said inflation was too fast and suggested interest rates will rise. It may reach 81 cents in coming days, Schuster said. Before yesterday, it had spent just one day above 80 cents in the last decade.

There's an 84 percent probability the central bank will increase the overnight cash rate target a quarter percentage point to 6.50 percent by June, compared with 10 percent before Edey's comments, 30-day interbank interest-rate futures show.

The Bank of Japan yesterday kept borrowing costs at 0.5 percent, the lowest in the industrialized world.

Looking Quite Expensive

``The Australian dollar will strengthen and test 82 cents until the RBA signals an end to its tightening cycle,'' said Sue Trinh, a currency strategist at RBC Capital Markets in Sydney.

The U.S. Federal Open Market Committee will keep its benchmark rate at 5.25 percent today, according to all 94 economists surveyed by Bloomberg News. Futures traders are betting policy makers will cut rates later this year.

The spread in yields between benchmark two-year Australian and U.S. Treasuries widened to 1.70 percentage points, the most since April 2005, from 1.60 percentage points at the end of last week. It's averaged 1.06 points in the past year.

Investors who don't already own the Australian dollar should hold off from buying as it was ``expensive,'' UBS AG, the second- biggest currency trader, advised in a research note today.

``The Australian dollar is looking quite expensive relative to its yield differentials,'' said Ashley Davies, a Singapore- based currency strategist. ``We're not sure this warrants a positive stance on the Australian dollar. Rather, investors already long should hold on to those positions.'' A long position is a bet a currency will rise.

Harder for Exporters

``The fact that the Australian dollar is high makes it harder for Australian exporters,'' Costello told reporters in Canberra. ``It moves in relation to trade flows, the global economy and interest rates.''

A stronger currency erodes the value of exports that contribute about 20 percent to the economy, which is heading for a 16th straight year of growth as consumers and companies increase spending. Australia is the world's largest exporter of wool and the biggest producer of iron ore and coal.

The Australian dollar's gains are being exacerbated by exporters who are buying it to protect profits against further currency appreciation, ANZ's Schuster said.

`In Its Knapsack'

The currency held gains today as Westpac Banking Corp. and the Melbourne Institute's leading index, a gauge of future economic growth, rose 0.1 percent from December to 244.4. The index's annualized growth rate was 4.8 percent.

``The flows into Australia and the Australian dollar have been strong,'' said Stephen Koukoulas, chief Asia-Pacific strategist at TD Securities Ltd. in Sydney. It ``looks to have further upside potential, especially if the RBA turns out to have more than one interest-rate rise in its knapsack.''

Australia's currency will gain to 82 cents in a month and 84 in three, he said.

One-month implied volatility on options on the Australian dollar versus the U.S. currency were 8.15 percent from 7.4 percent at the start of the week and an average of 7.46 percent over the past year. Traders quote implied volatility, a measure of expected price swings, as part of setting option prices.

source:www.bloomberg.com