The Australian dollar is acting like an emerging market currency

[SYDNEY] Australia's dollar is finding itself in unusual company these days, getting sold along with former emerging market darlings such as the Indonesian rupiah and Indian rupee.

As a rout grips developing markets, the Aussie - viewed as a barometer for global risk appetite - is also bearing the brunt of investor angst. While nobody's expecting the currency to be swept up in full-fledged contagion, it's being battered due to the economy's close ties to China and reliance on offshore funding.

"Australia's economic growth has become more highly linked to the Asia region through commodities, services and as a source of capital," said Greg Gibbs, founder of Amplifying Global FX Capital Pty. "So the Aussie is used as a proxy trade for risks for the region, even if they have not materialized in weaker growth in Australia or lower commodity prices."

The Aussie's fall from grace - it was trading at parity to the US dollar as recently as 2013 - is the flip side of previous gains that were fueled by years of record Chinese demand for its commodities. Australia's currency is also suffering along with emerging-market assets as global funds withdraw in favor of returning to the greenback.

The Aussie has slumped 3.3 per cent in the past month. That matches the decline in the rupiah, while the rupee has tumbled more than 4 per cent.

The drivers of the recent losses differ to some extent. While emerging-market currencies have been pummeled by contagion fears from the financial turmoil in Turkey and Argentina, Australia's dollar has been dented by the impact of tighter global liquidity on its banks.

LIQUIDITY TIGHTENS

Three-month funding costs have risen almost 8 per cent this year, and three major Australian banks have pushed up mortgage rates, spurring concern this will damp economic growth and make it even less likely the Reserve Bank of Australia will raise interest rates.

"The key links are that Australian banks rely on offshore funding for a significant part of their books," said Mr Gibbs, who previously worked at the RBA's foreign-exchange desk. "We can see some of the direct effects of tightening global liquidity via a moderate uptick in Australian bank funding costs and some lift in mortgage rates."

The next risk factor for the Aussie will come from a possible escalation of the US-China trade war. With the public comment period for new American tariffs on Chinese goods ending on Thursday, the expectation is that US President Donald Trump will impose additional duties soon.

China buys more than a third of Australia's exports - equivalent to about 8 percent of the South Pacific nation's gross domestic product. The dependence helped drive the correlation between the Aussie and the offshore yuan to the strongest on record last month.

"China has always had an outsized impact on AUD due to China being Australia's main export partner," said Marcus Wong, who was the most accurate forecaster for the Aussie in Bloomberg's second-quarter rankings. "As an instrument to express risk-off sentiment, the Aussie has been hit not just by rising protectionism concerns but also EM worries as well."

The Aussie will probably extend losses to 70.60 US cents soon, said Mr Wong, a treasury strategist at CIMB Bank Bhd in Singapore. The currency was at 71.71 cents on Friday after dropping to a two-year low of 71.45 cents earlier this week.

BLOOMBERG