Strategic AUD Views - Mar 2011 Edited

8/6/2019 Strategic AUD Views - Mar 2011 Edited

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Nomura International plc

See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures

Strategic Currency ViewsFX Research and Strategy

The Australian Dollar: Remarkably resilient

AUD/USD forecast: We forecast AUD/USD to hold around parity in 2011 and

2012. We are tactically bearish AUD as China starts its tightening policy.

Country-specific factors: The market is pricing no RBA hikes this year. The

recent natural disasters in Australia mean the market now expects the hikes to be

delayed. We forecast negative growth for Q1 as a result of these floods, but growth

should pick up in the following quarters. We also think that, as China intensifies its

tightening cycle, demand for Australian exports could wane.

Global USD direction: We remain constructive USD, especially for the next few

months.

Global risk factors: We expect the risk environment to remain mildly risk-seeking

over the next few months, but we view the risk-reward on risky assets as limited atpresent.

Volatility: The volatility curve is slightly higher than one-month ago suggesting a

decline in market risk sentiment at present.

AUD trading views

We are currently flat AUD.

Economic outlook

We expect the Australian economy to have negativegrowth in Q1 2011, because of the recent floods, but

expect a turnaround in Q2. We forecast GDP to be

2.8% for 2011.

Inflationary pressures are expected to remain. Thefloods and cyclone are expected to provide upward

pressure, and we are forecasting CPI at 2.9% for

2011, reaching 3.4% in 2012.

In 2011, we expect commodity prices to continue torise. Similarly, export volumes should also rise over

the next few years but at a slower pace in 2011

because of the recent floods which have hurt trade

exports in Q1 and could persist through to Q2.

Nomura Market Nomura Market

Recent

Q1 11 0.98 1.00 1.27 1.32

Q2 11 0.98 1.00 1.23 1.30

Q3 11 1.00 1.01 1.22 1.31

End 2011 1.02 0.98 1.21 1.29

0.99 1.35

FX Forecast AUD/USD

AUD/USD AUD/NZD

16 March 2011Contributing Research Analysts

Geoffrey Kendrick+ 44 20 7103 [email protected]

ennifer Hau+44 20 7102 [email protected]

Terms of Trade (page 3) bullish

bullish

Valuation & competitiveness (page 8-9) very bearish bearish

Official Capital Flows (Page 12) bullish

Fiscal Policy (Page 12) very bullish

Housing (page 13) neutral

neutral

Note: Very bullish

Bullish

Neutral

Bearish

Very bearish

Global USD Direction

Global Risk Sentiment neutral

Key factors in the AUD outlook

Country-specific factors

Rate differential (page 2) Direction: bullis h

Global factors

Resource production (page 4-6)

Private Capital Flows (Page 10-11)

Mispricing: bearish

Source: Nomura, Reuters, RBA and IMF

2011 2012 2011 2012

Nomura 3.3 3.6 3.1 3.1

Consensus 3.2 - 3.2 -

RBA 3.8 4.0 3.0 3.0IMF 3.5 3.5 3.0 3.0

Economic Forecast

GDP Inflation
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]


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Nomura | Strategic Currency Views: AUD March 16, 2011

2

Policy rate (bullish short term)

The RBA kept rates unchanged at 4.75% at the March meeting as widely expected. Market expectations

have declined since the severe floods in December/January. Before the floods the market had priced ina hike in August this year, but it has now pushed back expectations. Although 4.75% is a low cash rateby historical standards, the RBA estimates that wider bank margins since the onset of the crisis (andAustralia's early adoption of Basel III rules) have added a further 150bp to average flexible mortgagerates. This puts the cash rate mildly into restrictive territory.

The RBA has now hiked rates seven times in 13 months, taking the cash rate from 3.0% to 4.75%. Oureconomists believe two more hikes are likely, one in May and another in Q3 leaving rates at 5.25% by theend of 2011. This would be a positive surprise compared with market expectations. The main risk to thisview is that the Bank stays on hold longer than expected, as per market pricing.

In its February quarterly Monetary Policy Statement, the RBA forecasts for core CPI inflation remainedunchanged at 2.75% for end-2011 and 3% for end-2012. This signifies a mild tightening bias. The Bankcontinues to suggest the level of AUD is helping to restrain inflationary pressures domestically. This means

that a stronger AUD reduces the likelihood of further RBA hikes from here.

The recent flood and cyclone are expected to have an upward pressure on inflation. We estimate 0.3pp willbe added to inflation from the higher cost of goods caused by a loss in production mainly from fruit andvegetables.

AUD/USD continues to trade at elevated levels and it remains higher than rate differentials would suggest.

Source: RBA, Bloomberg, Nomura.

4.25

4.50

4.75

5.00

5.25

5.50

Mar-11 Jun-11 Sep-11 Dec-11

Rate Expectations for Australia

Market

Nomura

%

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1

-3500

-2500

-1500

-500

500

1500

2500

Jul 95 Jul 98 Jul 01 Jul 04 Jul 07 Jul 10

RBA FX Intervention

RBA FX Intervention - lhs

AUD/USD - rhs

$AUD mn

RBAbuys AUD

RBAsells AUD

AUD/USD

0.5

0.6

0.7

0.8

0.9

1

1.1

0

1

2

3

4

5

6

7

8

Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11

AUD/USDRate diff

3M Bills Implied Rate differential

AUD 3M bank bill - US 3M T-Bill

AUD/USD 0.6

0.65

0.7

0.75

0.8

0.85

0.9

0.95

1

1.05

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

Jan 09 Jul 09 Jan 10 Jul 10 Jan 11

Futures Implied Rate Differential(Dec 2011 Contract)

Futures di ff

AUD/USD

%AUD/USD


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3

Terms-of-trade (bullish) Australia's terms of trade have increased rapidly

over the past few years. Export prices (mainlycommodities) have risen sharply, while Australia'simport prices (primarily manufactured goods)remaining subdued, especially in AUD terms as thecurrency has appreciated. The terms of tradecontinue to increase.

However, China (Australias number one exportdestination) has started tightening its policy, hiking1-year deposit and lending rates by 25bp and bankreserve requirements by 100bp since the beginningof this year. As China becomes more serious abouttightening, we could see growth in China wane,which could impact demand for Australiascommodity exports

Commodity prices rose sharply in January as aresult of the recent (Dec/Jan) natural disasters.The floods in Queensland had a significant impacton coal production, with around 25% of

Queenslands coal mines ceasing operations andanother 60% operating under restrictions. Exportswere affected because of damaged rail lines. Thisled to a lack of supply, causing coking coal pricesto rise. Cyclone Yasi also impacted commodityproduction from Northern Queensland, wherebanana crops, sugar cane and beef herds wereaffected.

In 2011 we expect commodity prices to continue torise. The increased concerns about events in theMiddle East have caused oil prices to rise, and wenow forecast them to rise as much as 30% in 2011.

Similarly, export volumes should continue to riseover the next few years, but at a slower pace in2011, given the recent floods. These hit tradeexports in Q1 and the effects could persist throughto Q2. We forecast export volumes to rise from23.4% of GDP in 2010 to 24.1% in 2011 and24.9% in 2012. We expect 2011 growth to coincidewith strong growth in demand from Asia ex-Japan.Growth will be negative in Q1 because of thefloods but should pick up in Q2 and for the rest ofthe year. In 2012 production of liquid natural gas(LNG) and gold should increase.

*Nomura Forecasts

*Note: Rural: livestock, wheat, wool, rice and other foods.Base Metals: Aluminium, Copper, Lead, Zinc, Nickel.

Non-rural: Coal, Iron Ore, Gold, LNG, Oil and Alumina.

Source: Bloomberg, DataStream, Nomura.

60

65

70

75

80

85

90

95

100

105

110

50

100

150

200

250

300

Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11

Nomura ToT

AUD TWI

ToT Index AUD TWI

0

20

40

60

80

100

120

140

160

180

Q11988

Q11991

Q11994

Q11997

Q12000

Q12003

Q12006

Q12009

Q12012

Australia exports vs commodity prices

AUD Export Volume index

Commodi ty Prices

Index 2009=100

80

100

120

140

160180

200

220


Export Prices

Import Prices

Index

0

50

100

150

200

250

Jan 97 Jan 00 Jan 03 Jan 06 Jan 09

Commodity Prices by components

Rural

Non-rural

Base Metals

Index 100 = 08/09

0

20

40

60

80

100

120

140

160

180

0

5

10

15

20

25

Exports vs Commodity prices

Total Exports - lhs

RBA Commod ity Prices -rhs

AUD bn Index


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4

Resource production (bullish long term)Chinese steel production vs iron ore and coking

coal exports from Australia (by volume) Natural gas and steaming coal exports from Australia

Iron ore exports from Australia to China vs total

China iron ore imports

Gross State Product

[last data point is Jun 2010]

Source: Port Hedland Port Authority, Australia Bureau of Statistics, Bloomberg, Nomura

Chinese demand for steel and energy has dominated Australia's export mix for the past decade. Chinese steelproduction has multiplied more than fourfold over the past seven years, seeing Australia's exports of iron ore

more than double.

In addition, the opportunities afforded by long-term Chinese energy contracts to Australia's LNG industry have ledto an almost exponential increase in production (all for export) of LNG off Australia's north and north-west

coastlines. The days of the original north-west shelf trains 1-3 (7.5 million tonnes annual production in the 1990s)

are now long gone (see Box 1 Liquid Natural Gas: Australia's new iron ore sized export in the report The

Australian Dollar: Its not all about Chinafor more details). Similar increases in productive capacity have occurred

in thermal (steaming) coal production and exports, assisted by huge upgrades to rail and port facilities in New

South Wales and Queensland.

From a structural perspective this has started to result in a genuine two-speed Australian economy. Thecommodity states (here represented by West Australia, Queensland and the Northern Territory) have grown by anannual average 4.1% over the past five years, in stark contrast with the 2.5% average for the rest of Australia.

While the risk of "Dutch disease" has gained little credence of late, we think it is something to consider longer

term.

50

100

150

200

250

300

50

100

150

200

250

300

350

400

450

03 04 05 06 07 08 09 10 11

China Steel Production - lhs

Iron Ore - rhs

Coal - coking - rhs

Index Index

0

500

1000

1500

2000

2500

1990 1994 1998 2002 2006 2010

Natural Gas

Coal - Steaming

AUD mn

50

100

150

200

250

300

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

China Total Iron Ore Imports

PortHedland Exports to China

Index

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

90 92 94 96 98 00 02 04 06 08 10

Rest of Australia

Queens land,Western Australiaand No rthern Territories

y-o-y growth
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5

Exports distribution by country in 2000 Exports distribution by country in 2010

Export distribution by goods in 2000 Export distribution by goods in 2010

Source: Bloomberg, CEIC, Australia Bureau of Statistics, Nomura

Chinese demand for steel and energy has resulted in a fundamental shift in Australia's export basket mix as well asthe destination of its exports. The 1990s Japanese iron ore and coal annual renegotiations have been gradually

replaced by Chinese negotiations for the same commodities, and are now conducted quarterly, for the first time in

2010.

Although in the 1990s Japanese iron ore and coal demand was important in terms of Australia's overall exportbasket, other exports such as gold, base metals and tourism still had a large role to play. By 2010, however, while

tourism remained important, a strong AUD has meant it has been gradually priced out by an ever greater surge in

iron ore and coal exports.

China

Other

HongKongJapan

S.Korea

NZ

Singapore

Taiwan

UK

US

EUChina

Other

Hong Kong

Japan

S.Korea

NZ

Singapore

Taiwan

UK US

EU

Alumia

Aluminium

BarleyLivestock

Coal -coking Coal -

Steaming

CopperCopper

OreCottonIron Ore

LeadNatural Gas

Nickel Ore

Nickel

PetroleumOil

Wheat

Wool

Zinc

SteelNon-

FerrousMetalsGold

Other goods

ServicesEducation

ServicesTourism

ServicesOther

Alumia AluminiumBarley Livestock

Coal -coking

Coal -steaming

Copper

Copper Ore

Cotton

Iron Ore

LeadNatural

GasNickelOreNickel

PetroleumOilWheat

WoolZinc

SteelNon-

FerrousMetals

Gold

OtherGoods

ServicesEducation

ServicesTourism

ServicesOther


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6

Box 1 One natural disaster after another: floods and cyclones

At the end of 2010 eastern states of Australia were hit with heavy rainfall which subsequently led to one of the

worst Australian floods experienced in a century. Half of Queensland was left submerged, an area as large as

France and Germany combined. The flood caused mass disruptions, affecting mining, agriculture, tourism and

transport. Furthermore, as the worst of the flood began to fade Australia was hit by Cyclone Yasi.

Flood impact

Australia experienced the worst flood in a century during December/January. At the peak of the natural

disaster, more than half of Queensland was flooded. Floods primarily affected Queensland (mainly Brisbane),

and some parts of Victoria.

The flooding severely hit coal production, particularly in the Bowen-Basin in central Queensland which is

home to 34 operational coal mines and supplies over half of Australias coal exports. The floods caused

around 25% of mines throughout Queensland to cease operations in December/January, with another 60%

operating under restrictions. While production has recommenced, damage to rail lines will limit the delivery of

exports for some time potentially till the end of Q1.

The Reserve Bank of Australia has estimated that the flood has caused a loss of production in the region of

25 million tonnes (around 8% of annual coal production). Australia supplies over 60% of the world s export of

coking coal (Figure 1), and the decline in production means prices are set to rise. Coking coal prices (whichare now set on quarterly contract rates) have risen, reaching US$330/tonne for Apr-Jun contracts, up from the

agreed Q1 benchmark price of US$225/tonne. The floods mean prices are set to remain high for a prolonged

period, as coal mines are unlikely to be able to make up for lost output given that they were probably already

operating at full capacity.

The floods also hit agriculture, either delaying planting of new crops or damaging the current crop. Although

there were initial concerns over wheat production, ABARE estimates wheat production reached 26.3 million

tonnes in 2011, 20% higher than last year. Only 5% of Australias wheat production is from Queensland, and

the floods have only slightly reduced forecast production. Although forecasts for New South Wales and

Victoria have been lowered since the floods, they are still double the quantities produced in 2009-10 (Figure

2).

CyclonesAs the flood waters subsided, Queensland was hit by another natural disaster, Cyclone Yasi.

Cyclone Yasi was a category 5 cyclone, the strongest to hit North Queensland this century. It caused mass

damage and chaos. We estimate that the initial loss of GDP growth in Q1 will be around AUD2bn or about

0.6pp nationally. The cyclone affected various commodities. We estimate 85% of banana crops, 15% of the

beef herd and 50% of sugar cane were lost in the disaster.

Figure 1. World coking coal exports Figure 2. Wheat production by state

Source: ABARE, Nomura Source: ABARE, Nomura

0

50

100

150

200

250

300

2008 2009 2010 2011f

Other

Russia

USA

Canada

Australia

million tonnes

0

2 000

4 000

6 000

8 000

10 000

12 000

NSW Vic Qld WA SA

200809

200910

201011 f

1000 tonn es


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7

The cost

The Federal government has estimated the direct cost of the floods to be AUD5.6billion. It has since

introduced a one-off flood levy on income tax. The tax, which will apply for the 2011/12 tax year (July-June in

Australia), is set at 0.5% of income above AUD50,000 and 1.0% on income above AUD100,000. The

government expects this to raise AUD1.8bn. In addition to this AUD1.8bn, the Federal government is to spend

another AUD3.8bn, which will be fully funded by cuts elsewhere. There should be no net expansion on

government spending as a result of the floods, as the government aims to return the fiscal balance to surplusby 2012-13.

The RBA has forecast the flood impact to lower GDP for Q4 2010 and Q1 2011 by 0.25% q-o-q, largely

because of the loss in exports from coal production as well as other output. However, assuming there are no

further setbacks, coal production is expected to resume to full capacity by the second half of the year. With

reconstruction and repair to take place after the disaster, the RBA is estimating the cost of rebuilding public

infrastructure and dwellings to be around AUD8billion spread over two years (from mid-2011). This is

expected to boost GDP by 0.25% during the quarters when the rebuilding takes place. The RBA has therefore

revised up its forecast for 2011 GDP to 4.25% y-o-y (up from the November forecast of 3.75%) and 2012 to

4%. However, our economists are forecasting more modest growth during 2011 of 3.3% y-o-y and 3.8% in

2012.

It is assumed that a natural disaster will cause negative growth due to loss of production and output, but thatthe following quarters should experience a pick-up in activity as clean-up and rebuilding commences. Our

economists forecast the damage from the December/January flood and from Cyclone Yasi will take 1.1% off

Q1 GDP, forecasting -0.3% q-o-q for Q1 GDP, and then a pick-up in growth in Q2 to 1.9% q-o-q, and in Q3 to

1.6% q-o-q. However it is important to note that as the new flood levy comes into force in July this year,

potential spending will be reduced.

Figure 3. GDP Forecast

Source: Nomura Global Economics

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Mar 10 Sep 10 Mar 11 Sep 11 Mar 12

GDP Forecast pre-floods

GDP forecas t post-floods


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8

Valuation (very bearish long term)

From a longer-term valuation perspective AUD continues to look stretched to the topside: Australia'sterms of trade and commodity price basket have now surpassed the peaks reached in 2008. AUD has also

printed fresh all-time highs against USD and on a TWI basis at the start of this year.

The big positive driver for AUD has been China, its impact on commodity prices, and also the demand forAustralian exports (volumes). We think commodity prices could clearly push higher, but the inflationary

consequences of higher commodity prices for China could increase the likelihood of Chinese tightening

measures. This would reduce an otherwise positive AUD stimulus, so risks are becoming skewed to the

downside (for more details seeAUD: Getting bearish, 1 February 2011).

Source: Bloomberg, OECD, Nomura.

USD GBP EUR JPY AUD NZD CAD CHF NOK SEK

REER (10y) -10.96 -13.39 3.43 12.68 22.33 -1.49 17.97 14.97 3.62 0.02

REER (20y) -9.93 -12.04 -3.31 13.71 30.37 2.35 22.13 14.46 6.82 -7.30

REER (30y) -12.90 -12.37 -6.54 23.82 25.33 3.18 17.64 16.89 5.41 -11.72

PPP (OECD) -25.09 6.79 8.80 26.49 50.97 11.64 19.01 38.80 38.24 28.22

PPP (Adjusted) -12.49 0.42 0.92 1.27 50.78 19.98 23.71 -0.82 3.68 4.91

G10 Valuation (%)

51.0

-40

-30

-20

-10

0

10

20

30

40

50

60

1971 1979 1987 1995 2003

AUD/USD deviation from PPP%

AUD Overvaluation

25.3

-30

-20

-10

0

10

20

30

40

50

60

1964 1970 1976 1982 1988 1994 2000 2006

REER deviation from 30-year average

AUD Overvaluation

%

60

65

70

75

80

8590

95

100

105

110

50

100

150

200

250

300


Nomura ToT

AUD TWI

ToT Index AUD TWI

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

0

20

40

60

80

100

120

140

160

Jan -97 Jan -00 Jan-03 Jan -06 Jan -09

RBA Commodity Prices

AUD/USD

Index AUD/USD
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9

Australia total exports vs total imports of maintrading partners

Manufacturing exports picked up at the end of 2010. Butthis sector only counts as a small portion of Australias

total export income.

In terms of total exports, Australias market share hasincreased significantly over the past few years, with

continued growth in exports (due to increase productive

capacity) despite a drop in export market potential during

the crisis.

Australias unit labour costs have increased graduallyover time. We find that AUD vs USD and NZD is currently

at relatively fair values compared with the REERs

adjusted for bilateral CPIs and ULCs. However, with

AUD/JPY we find that AUD is relatively undervalued

looking at bilateral ULCs. *Export market share based on the top trade weighted tradingpartners to Australia ex China.

Source: Bloomberg, DataStream, OECD, RBA, Nomura.

-60%

-40%

-20%

0%

20%

40%

60%

80%

Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11

Manufacturing Exports

AustraliaNew ZealandUKNorway

y-o-y

80

100

120

140

160

180

200

220

Q11995

Q11997

Q11999

Q12001

Q12003

Q12005

Q12007

Q12009

Total imports of maintrading partners

Australia exports

Index 100=1995

0.7

0.75

0.8

0.85

0.9

0.95

1

1.05

1.1

1.15

1.2

Q11995

Q11997

Q11999

Q12001

Q12003

Q12005

Q12007

Q12009

Australia export market share

Australia exports/ Totalimpo rts of main tradingpartners

ratio

60

80

100

120

140

160

180

200

Q11990

Q11993

Q11996

Q11999

Q12002

Q12005

Q12008

Unit Labour Cost

UKGermanyNorwayNew ZealandJapanUSAustralia

Ind ex 100 = 1990

50

70

90

110

130

150

170

190

Jun 96 Jun 98 Jun 00 Jun 02 Jun 04 Jun 06 Jun 08 Jun 10

AUDJPY bilateral real exchange rates

AUDJPY adjusted by CPI

AUDJPY adjusted by ULC

AUDJPY Spot

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1


AUDUSD bilateral real exchange rates

AUDUSD adjusted by CPI

AUDUSD adjusted by ULC

AUDUSD Spot

1

1.1

1.2

1.3

1.4

1.5


AUDNZD bilateral real exchange rates

AUDNZD adjusted by CPI

AUDNZD adjusted by ULC

AUDNZD Spo t


10/18


10

Private capital flows ( neutral)

The Australian current account has persistently been in deficit owing to continued net outflows from its

income balance. However, it has been narrowing since early 2010.

In recent quarters there has been an improvement in the goods and services trade balance mainly owing torising commodity prices. This has subsequently reduced the current account deficit.

Australia is considered an attractive investment destination with consistent portfolio inflows, a majority beingpurchases of bonds. Foreign investors have shied away from Australian stocks since Q3 2009. Domesticinvestors have reduced their investments abroad over the past two quarters with a notable reduction ininvestments in both foreign stocks and bonds.

Direct investments in Australia have been volatile for years. The recent decline in foreign investments could beattributed to the increase in value of the Australian dollar, which is considered to be 40% overvalued on a PPPbasis.

Source: Australia Bureau of Statistics, Bloomberg, Nomura.

-100

-80

-60

-40

-20

0

20

40

Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010

Current Account Balance

Inco me BalanceGoods and services balanceCurrent TransfersCurrent Account

AUD bn,annulaised

-150

-100

-50

0

50

100

150

200

Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010

Financial Account Flows

Net Portofl io InvestmentOther InvestmentNet Direct InvestmentFinancial Account

AUD bn,annulaised

-200

-150

-100

-50

0

50

100

150

200

250

Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010

Portfolio Inflows

Bonds

Equity

total inflow

AUD bn,annualised

-200

-150

-100

-50

0

50

100

Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010

Portfolio Outflows

Bonds

Equity

total outflow

AUDbn,annualised


11/18


11

Private capital flows: M&A ( neutral)

6M Aggregate Pending Flows Adjusted net pending flows with probabilityadjustment vs 6M net pending flows

The Australian M&A picture has weakened. Australias six-month aggregate pending flows are reporting anexpected inflow of $11bn in February. When looking at the actual likely FX impact, the adjusted netpending flow

1indicates a small inflow of only $1.4bn.

There continues to be some sizable announced deals coming into Australia, but it is important to note that notall the flow listed below will provide a cross-border inflow. Taking into account just cross-border cash flow andthe likelihood of the deals completing (based on the current trading stock price to the offer price), we find theadjusted net pending inflow to be just $2bn.

There has also been an increase in outflows from announced deals from Australia with outflows totalling$10.3bn in February.

Australia is currently ranked fifth in the G20 in terms of adjusted net pending inflow.

*Note: Estimate for Q1 2011

Source: Thomson Reuters, Nomura.

1) Adjusted net pending flows are estimated by taking major deals and adjusting cross-border cash flows according to additional information we know about the dealthis can include financing details, a differing currency for the working capital. This is then adjustment to incorporate the likelihood of a deal being completed. For moredetails seeM&A activity slows in January, 1 February 2011.

-40

-30

-20

-10

0

10

20

30

99 00 01 02 03 04 05 06 07 08 09 10 11

Pending flows - total

Pending flows - cash

$ bn

-20

-15

-10

-5

0

5

10

15

20

CNY JPY BRL MXN EUR AUD CAD KRW GBP USD

6M Adjusted net pending flow - withprobability adjustment - cash

6M Net Pending Flow - cash

US$bn

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

Mar-05 Sep-06 Mar-08 Sep-09 Mar-11

Net cash Announced

$US bn$US bn

-20

-15

-10

-5

0

5

10

15

20

25

Mar-05 Sep-06 Mar-08 Sep-09 Mar-11

Net Total Completed$US bn

Acquirer Target Total Value

($m)

Cash

($m)

Equity

($m)

Outflows BHP Billiton Ltd Australia Chesapeake Energy Corp US 4,750 4,750

Equinox Minerals Limited Australia Lundin Mining Corporation Canada 4,700 2,400 2,300

Inflows Singapore Exchange Ltd Singapore ASX Ltd Australia 8,235 3,817 4,507

Rio Tinto PLC United Kingdom Riversdale Mining Ltd Australia 3,781 3,781

AXA SA France AMP Ltd Australia 2,631 2,631
http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355http://grp.uk.nomura.com/research/getpub.aspx?pid=416355


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12

Official capital flows (bullish)

% of allocated reserves

Change in holdings (per quarter) * Other currencies include AUD,NZD, CAD, SEK and NOK.

In Q3 2010 there was strong demand for other currencies from the SNB. However, the COFER datashowed that official demand was moderate during that period. The latest SNB FX intervention datashowed there were no additional purchases of other currencies in Q4. We believe official flows will

remain supportive for AUD but are unlikely to drive AUD/USD any higher from current levels. During H1 2010 we saw strong inflows into other currencies suggesting central banks started to diversify

their foreign exchange reserves away from USD and EUR (because of continued debt issues in peripheralEurope and growth and QE uncertainties in the US). However, recent data suggest central banks aresticking to USD and EUR, rather than pursuing aggressive diversification strategies.

The most recent IMFs COFER data showed moderate demand for other currencies in Q3. Much of thisdemand was driven by the SNB FX intervention the Bank bought CHF5.9bn of other currencies (defined asAUD, SEK, DKK and SGD, although we suspect the bulk was in AUD) in Q3 2010. However, recent SNB FXintervention data showed no additional purchases during Q4.

Source: IMF, Nomura.

Fiscal policy (very bullish)

Source: IMF, Nomura.

Australia has one of the strongest fiscal positions in the G10. In the current environment, where investorsare concerned about sovereign risk, this is bullish AUD.

Australia has one of the strongest fiscal positions and has the lowest gross debt within the G10. The currentfiscal deficit of 4.1% of GDP in 2010 is widely expected to shrink gradually over the next few years, with therecent government budget for 2010-11 projecting a fiscal surplus by 2013.

The government estimates the direct cost of rebuilding after the severe floods experienced inDecember/January at AUD5.6bn. The government has proposed a flood levy on taxable incomes to fund therepairs. This is set to raise AUD1.8bn. The rest of the rebuilding cost will be funded by AUD3.8bn of netbudget cuts. This shows the governments strong commitment to return its budget to a surplus by 2012-13.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09

OTHER World

OTHER World

-10

-5

0

5

10

15

20

25

30

35

Jun-99 Jun -01 Jun-03 Jun-05 Jun-07 Jun-09

$bnOTHER

-15

-10

-5

0

5

10

15

Irelan

d

UnitedState

s

Japa

n

UnitedKingdo

m

Greec

e

Spa

in

France

Portug

al

Netherlands

Belgiu

m

Ita

ly

Austr

ia

German

y

NewZealan

d

Luxembou

rg

Canad

a

Australia

Finland

Swede

n

Switzerlan

d

Norwa

y

2011 Fiscal Deficit%GDP

0

50

100

150

200

250

J

apan

Greece

Italy

Belgium

Ireland

UnitedS

tates

Fr

ance

Por

tugal

UnitedKingdom

Ca

nada

Germany

Au

stria

S

pain

Netherlands

No

rway

Finland

Sw

eden

Switze

rland

NewZealand

Aus

tralia

Luxemb

ourg

2011 Gross Debt%GDP


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13

Housing ( neutral)

House price growth

Source: Reserve bank of Australia, Bloomberg, Australia Bureau of Statistics, Nomura

House prices could be topping out. They have declined year-on-year since early 2010. This could be due tothe mildly restrictive mortgage rates that households face; banks have added a further 150bp to averageflexible mortgage rates since the onset of the crisis.

Source: Bloomberg, Australia Bureau of Statistics, Nomura

0.5%

1.0%

1.5%

2.0%

2.5%

100,000

120,000

140,000

160,000

180,000

200,000

220,000

240,000

1980 1985 1990 1995 2000 2005 2010

Building Approvals vsPopulation Growth

Build ing Approvals -lhsPopulation Growth - rhs

annualised y-o-y

-20%

-10%

0%

10%

20%

30%

40%

50%

60% Sydney

Melbourne

Brisbane

Adelaide

Perth

%y-o-ygrowth

0

2

4

6

8

10

12

14

16

18

1980 1984 1988 1992 1996 2000 2004 2008

Real Household disposable income

Real Household consumption

% y-o-y

-6%

-4%

-2%

0%

2%

4%

6%4

5

6

7

8

9

10

11

12

1980 1984 1988 1992 1996 2000 2004 2008

Unemployment rate - lhs

Employed - rhs

% % y-o-y, inverted


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14

Uridashi/toshin flows (bearish potential)Outstanding Toshins by currency

Lower yields since 2008 have reduced the attractiveness of uridashi investments to Japanese retail investors.

However, with rates in Australia sustainably higher than in New Zealand for the first time under the currentcentral bank regimes (the RBNZ introduced its OCR framework in 1999), all of the Australasian uridashi flowshave been going to Australia (in the most recent three-month period 76% of these combined flows found theirway to Australia compared with an average of 67% in pre-crisis 2007).

The recent floods could cause concern for Japanese investors and therefore impact flows into Australia. Thissuggests a further sharp increase in toshin flows to Australia is now less likely.

Source: Bloomberg, Nomura.

Risk environment ( neutral)

*A proxy for Global liquidity is calculated by looking at globalcentral bank reserves vs money in circulation in US and Japan

Historically, AUD/USD trades closely with the global risk environment. However, recently there has been adivergence between long-run GRAM+ and AUD/USD.

We find AUD also trades with global liquidity. AUD gained vs GBP, EUR, CHF and USD since early 2009, asglobal liquidity has started to grow strongly again, following the dip in 2008.

Source: CEIC, Bloomberg, Nomura.

3

4

5

6

7

8

9

0

1

2

3

4

5

6


AUD issuance

AUD 3Y Swap

%Uridashi Issuance AUD bn

0

5

10

15

20

25

30

35

40

99 00 01 02 03 04 05 06 07 08 09 10 11

Others

Latin America

XJ-Asia

Other Europe

Euroland

Canada

New Zealand

Australia

UK

US

(\tn)

(CY)

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

Apr 92 Apr 96 Apr 00 Apr 04 Apr 08

Long-Run Gram+

AUDUSD

AUDUSDLR GRAM+ Long Run GRAM+ vs AUDUSD

-30%

-20%

-10%

0%

10%

20%

30%

40%

-10%

-5%

0%

5%

10%

15%

20%

25%


Global Liquidity vs AUD returns

Global l iquidity proxy

AUD vs GBP, EUR, CHF andUSD

% y-o-y proxy % AUD returns


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15

Positioning (bearish)

AUD IMM positioning is currently at extended levels of US$7.44bn. It is just below the all-time high seen inApril 2010.

AUD TFX positioning is also at extended levels reaching an all time high of JPY210bn.

Source: Bloomberg, CME, TFX, Nomura

Implied volatility

The volatility curve is a slightly higher than one-month ago suggesting a decline in market risk sentiment.

Implied volatility in AUD/USD options is now at its long-term average and is relatively similar to the historicalvolatility.


0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

-4

-2

0

2

4

6

8

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

IMM Positioning

AUD IMM positioning - lhs

AUDUSD - rhs

$US bn AUD/USD

50

60

70

80

90

100

110

120

0

50

100

150

200

250

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

TFX Positioning

AUD TFX positioning - lhs

AUD/JPY - rhs

JPY bn AUD/JPY

9

10

11

12

13

14

15

16

1w 2w 3w 1m 2m 3m 4m 5m 6m 1y 18m 2y

Volatility Curve

Now

1-mth ago

3-mth ago

vo l

5

10

15

20

25

30

35

40

45

50 VolatilityHistorical

Implied


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16

Data surprise index (bearish)Our growth surprise index has been on a decliningtrend since 2010. At the end of last year we sawlower than expected Q4 CPI, Q3 GDP and tradedata. But recent employment data came in betterthan expected, causing the index to move higher.

There has been a large divergence between theindex and AUD/USD since the middle of last year.AUD/USD has got progressively higher while theglobal surprise index has declined. This suggeststhat AUD/USD should trade lower as AUD/USDconverges towards the index.


0.6

0.65

0.7

0.75

0.8

0.85

0.9

0.95

1

1.05

1.1

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5Data Surprise

AUD GSI

AUDUSD

AUD/USDGSI


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Nomura | Global Foreign Exchange Research March 16, 2011

17

APPENDIX A1

ANALYST CERTIFICATIONS

We, Geoffrey Kendrick and Jennifer Hau, hereby certify (1) that the views expressed in this report accurately reflect my personal views aboutany or all of the subject securities or issuers referred to in this report, (2) no part of my compensation was, is or will be directly or indirectlyrelated to the specific recommendations or views expressed in this report and (3) no part of my compensation is tied to any specific investmentbanking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures

Mentioned companies

Issuer name Ticker Price Price date Stock rating Sector rating Disclosures

Rio Tinto RIO LN 3964p 11-Mar-2011 Buy Bullish 49,141

Rio Tinto Ltd RIO AU 79.15 AUD 14-Mar-2011 Not Rated

Disclosures required in the U.S.

49 Possible IB related compensation in the next 3 monthsNomura Securities International, Inc. and/or its affiliates expects to receive or intends to seek compensation for investment bankingservices from the company in the next three months.

Disclosures required in the European Union

141 Analyst shareholding in covered companyAn analyst who was involved in preparing the research recommendation in respect of Rio Tinto plc referenced in this report, or a memberof the analysts household, holds securities of the subject company

Online availability of research and additional conflict-of-interest disclosures:

Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG andTHOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS andBLOOMBERG.

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Nomura | Global Foreign Exchange Research March 16, 2011

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Strategic AUD Views - Mar 2011 Edited

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