ft.com/alphaville

The latest (corporate) news out of Australia may seem a bit grim. As the FT reports on Wednesday, shares in Brisbane-based ABC Learning Centres, the world’s biggest listed childcare provider, initially fell almost 70 per cent on Tuesday after a drop in earnings surprised investors and ignited fears over its debt.

Although ABC Learning has its own particular problems, its woes prompt Lex to reflect on how Australia is “markedly susceptible to the US-seeded credit crunch”. Citing recent Citigroup research, Lex points out the Aussie stock market is heavily tilted towards financials, and if you include real estate investment trusts, the total weighting is more than 40 per cent. Moreover, they have quietly notched up significant debt levels, it notes.

Australian companies often look towards the US as a natural market for expansion — at least until they experience American-style cut-throat competition. Operating in Australia, a country that has experienced 16 years of economic growth, has encouraged companies to gear up to improve returns — on a simple average basis, Citigroup calculates net debt/equity for Australia’s ASX index of companies has risen to 38 per cent …although, admittedly, much of this has been accrued by infrastructure-type funds.)

There are other reasons Australia is exposed — with “more pain to come”, adds Lex:

Bank lending surged 20 per cent last year, and consumers are still racking up debt. On several measures, the Australian householder is more indebted than his US counterpart. Worse, homeowners — and businesses — are not only suffering from the swollen spreads that are a global phenomenon but also higher base rates as the central bank continues aggressively to tighten rates.

It might be enough to rattle nerves in the currency markets and, indeed, the high-yielding Aussie and New Zealand dollars slipped a little on profit taking against the yen early Wednesday morning, the Aussie losing 0.4 per cent to Y99.88 while staying flat against the US dollar at $0.9285, reports the FT.

Furthermore, ABC’s shock news has not stopped the Australian sharemarket rising over the last few days. And while some companies are in debt, Australia’s central bank is still raising interest rates and is clearly not overly worried because - in the words of one observer, “most of the debt is well serviced and inflation is clearly a problem”.

Broadly speaking, the Aussie dollar is heading for a bull run, says Richard Grace of Commonwealth Bank of Australia, in a Tuesday note.One of Australia’s savvier currency strategists, Grace this week changed his outlook on the currency from “neutral” to “bullish” and sees it hitting $0.96 within the next three months, up from the current level of about $0.92.

The main reason why the Aussie has not climbed higher so far this year is that the global growth outlook for 2008 was revised lower at the start of the year due to the slowing in the G-7 economies, notes Grace. However, since the downward revision to global growth, numerous indicators have moved to suggest the global economy may not be as weak as initially feared:

• Base metal prices have risen more than 20%
• Oil prices have increased to record a close above US$100 per barrel
• The CRB commodity futures index has pushed to a fresh record high
• Japan’s GDP growth has surprised to the upside
• Chinese economic data has remain strong
• Global shipping costs have picked up again.

The risk is now that the market re-rates the AUD higher, says Grace, as participants come to realise that first, the global economy does not appear to be slowing as much as initially expected, and second, the Reserve Bank of Australia will deliver the interest rate hikes it is threatening - making the yield on Australian bond assets even more attractive. As the FT reported last week, the Aussie surged to a three-month high on February 19 after the minutes of the RBA’s policy meeting boosted expectations for further interest rate rises. The RBA raised interest rates 25bp to 7 per cent at its February meeting in an attempt to stem domestic inflationary pressures. However, the minutes surprised investors, revealing the decision between choosing a 25bp and 50bp increase was “finely balanced”.The main near-term risk to the Aussie’s predicted climb, in Grace’s view, comes from comments by China’s central bank. The PBOC stated recently that, as a result of inflation pressures, it will now select an “optimum” package of currency, interest rate and money-supply measures.

This really involves a widening of the Chinese exchange rate band. But the market may interpret this as meaning slower Chinese growth, and hence a little AUD negative, even though the PBOC issued a fresh forecast of 10 per cent GDP growth for 2008. If the widening of the currency band occurs before March 4 (when the RBA will probably raise interest rates), the AUD will quickly recover. If the announcement comes after March 4, the AUD may take a little longer to recover, but it will still recover.

So, concludes Grace: Buy AUD/USD on dips below $0.91; buy AUD/EUR on dips below €0.62; and buy AUD/GBP on dips below £0.46. Meanwhile, he says, accumulate USD/JPY below Y106.80.