23 January 2017
Over the past week Australian shares were 1.2% lower. Shares in developed countries were 0.3% lower with the US market 0.1% lower. Shares in emerging markets lost 0.3%. The Australian dollar was 0.7% higher at 75.55 US cents. The 10 year bond yield in Australia was 0.09% higher at 2.78% while in the US, the 10 year bond yield closed the week 0.07% higher at 2.47%. The oil price gained 0.1% to 52.42 US dollars per barrel.
There have been positive signs of improvement in trading conditions for Australia. A useful statistic is the terms of trade. The terms of trade measures the average price of exports relative to the average price of imports. It could be described as a measure of a country’s relative competitiveness in terms of what it sells offshore against what it buys from other countries.
Recently Australia’s terms of trade started to improve a little, as shown in the chart below.
The chart tells an interesting story, we can see that Australia’s terms of trade grew strongly to historically high levels during the mining boom and then tailed off sharply. The recent uptick is only small but, relative to history, Australia’s terms of trade remain at high levels. Recently, there’s been a price uplift in key commodities that Australia exports, most notably iron ore and coal. This is due to the recent increase in demand from China, combined with China’s own cuts to bulk commodity production. This price uplift has flowed through to an improved terms of trade.
Stronger terms of trade would generally be regarded as good for an economy. Effectively it makes a country richer as they can purchase more imports for a given level of exports. This can have a positive effect on consumption of goods and services, which generates economic activity. A strong terms of trade could also lead to a stronger Australian dollar. This is because other countries need more Australian dollars to purchase imports from Australia than they receive for their exports to Australia. This can have a positive impact in terms of lower inflation in Australia as the cost of imported goods is lower with a strong Australian dollar.
Overall an improved terms of trade should be considered a positive development for Australia. However we should also be realistic that this was more a result of good fortune than anything else, as commodity prices are out of our control.