I think that investing on the basis of macroeconomic forecasting...

I think that investing on the basis of macroeconomic forecasting is a bit of a fool's errand, because it is very difficult to sustainably predict what economic variables, such as exchange rates, will do over any forecast period.

However, in the case of the A$, there are some very significant developments in bond markets which have been having an impact on the currency for some time - for the past 12-18 months, at least - and which have intensified in recent months.

The chart below shows the difference in the yield on Australian government 10-year bonds compared to US ten-year treasuries. For most of the time, Australian yields exceeded US bond yields, with the spread hitting a multi-decade high at about the peak in the commodity cycle in around 2010/20111.

But since then the differential started to decline in a secular fashion and, about 12 months ago, it went negative, and it has become increasingly negative until today, when US 10-Year Treasuries are yielding a full 60bp more than Australian 10-Year bonds.

This is, to a large degree, due to a collapse in the yield on Australian government 10-Year bonds, from around 270 bps in the middle of 2018, to a little over 200bp presently (driven, presumably, by the alarming fall in the housing market, as well as falls in consumer sentiment and business confidence, all ahead of a federal election out of which it looks like will emerge a future federal government with articulated policies involving some severe fiscal constraints).

To the extent that interest yield differentials are correlated with relative currency strength, to which the chart below attests, these developments in bond markets do not confer any great deal of support for the Australian dollar, thinks the novice economist in me.  And with the recent sounds emanating out of the RBA taking on a decidedly muted tone when it comes to monetary policy, I'm not sure any support will be forthcoming for some time.





Naturally, for SDI - with its overwhelmingly Australian dollar denominated manufacturing and cost base, at the same time invoicing almost 90% of its sales in non-A$ terms - this interest rate differential overhang on the A$ is a quite big deal.

Already, the first order impact of this was seen in the company's latest result and if this dynamic persists in coming months, then SDI will surely report a record half-yearly result (and record full-year result).


(Of course, it could be that I've just gone and jinxed the company's prospects by raising this discussion because- given the vagaries of economic variables and the millions of factors that determine them -  some extraneous, left-field event might suddenly materialise out of nowhere next week, causing the trends in the chart above to smartly reverse and for the entire thesis to unravel.)