Canada, Australia and New Zealand are rich countries, but currency traders are watching them with interest for signs of the sort of malaise that often hits emerging markets when the U.S. dollar is rising.
Only a few years ago, comparatively high interest rates and solid economic performance made these countries a destination for investors seeking solid returns at a moderate risk. But rising U.S. interest rates are hitting their currencies and diminishing their attractiveness to overseas capital, an unwelcome development for economies that have relied increasingly on inflows of foreign investment to finance current account deficits.
The currency declines stand to add to existing weaknesses in these economies, which are driven in part by commodity exports and feature deep trade ties with China—another red flag as trade tensions mount.
While few expect Australia, Canada and New Zealand to suffer the type of shocks that have rocked Turkey and Argentina this year, the plight of the non-U.S. dollars underscores the risks associated with rising U.S. rates and dependence on global capital flows for financing.
The Australian dollar has fallen around 6.2% this year, hit by falling commodity prices and fears that years of debt-fueled prosperity have left it vulnerable to an economic or market shock. Household debt as a share of disposable income has climbed to almost 200%, putting it among the highest levels among developed countries. Those households could be subject to a severe shock if a sharp fall in the country’s currency triggered a rise in interest rates, Moody’s Investors Service warned last month.
For now, the Australian currency has been hurt by the central bank’s reluctance to raise rates. A depreciating Australian dollar could curb investor appetite for the country’s assets and raise the risk of destabilizing outflows of foreign capital, Moody’s said. Net foreign debt is now at 56.5% of gross domestic product, up from 37% of GDP two decades ago.
“Australia is more externally vulnerable than most AAA-rated sovereigns given the economy and financial system’s dependence on external financing,” Moody’s said.
Should a fresh emerging markets crisis break out, “there’s little doubt that the Reserve Bank of Australia would again regard the currency as the first line of defense, and allow it to fall quite substantially,” said Saul Eslake, a former chief economist for Bank of America -Merrill Lynch in Australia.
Trade worries have also pressured Canada, where the Canadian dollar—known as the loonie—is down 3.5% this year. Robust growth in Canada’s economy has pushed up inflation to a seven-year high and spurred employment, allowing the Bank of Canada to raise rates four times since 2017.
But heightened worries over the fate of the North American Free Trade Agreement and a chill in the housing market have made investors wary, a worrying development for an economy that leans heavily on investment from across its borders.
Foreign purchases of Canadian stocks and bonds have slowed to 43.7 billion Canadian dollars ($33.5 billion) in the first half of the year, down more than half from the same period last year. At the same time, the country’s current account deficit rose to just below C$19.5 billion ($15 billion) in the first quarter.
That financing gap will likely put pressure on the Canadian dollar, said Mark McCormick, head of North American FX Currency Strategy at TD Securities.
New Zealand’s dollar, known as the kiwi, has lost 5.7% this year. The Reserve Bank of New Zealand has indicated it intends to keep borrowing rates at record lows for the next two years, amid a softer economic growth outlook.
“We are experiencing a slowdown in economic activity that we project as temporary, but could be more prolonged,” the RBNZ said in a statement earlier this month. Trade wars, “or even their threat—can stall global investment and spending, and reduce demand for our products.”
New Zealand’s economy has struggled with many flagging indicators in recent months, including retail sales, car sales and housing-market activity.
The trio of countries is “reliant on international investors, yet are becoming less attractive to investors,” Mr. McCormick said. “It’s like a miniature version of emerging markets.”
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