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Notable over the first half of this week have been the varied opinions coming out of Germany on how to negotiate with the Greeks. Some German politicians favour the tough love approach, arguing that Greece has already been cut a great deal of slack and that life after Grexit would be tough but manageable.

Others are more flexible, wanting to avoid a Greek departure from the euro and appearing open-minded about granting Greece an extension. For her part, Merkel is playing her card close to her chest, reiterating overnight that no decision will be made until after she receives the latest report from the troika.

Guest post by Forex Broker FxPro

Against the backdrop of the latest chapter in this Greek drama, the mood music in markets yesterday was decidedly defensive, with European equities retreating by around 1.4% and bond yields declining. The German 10yr yield, for instance, fell by more than 10bp at one stage to 1.45%. High-beta currencies such as the Aussie lost more traction – at one stage the AUD fell back to near the 1.04 level again.

Commentary

A new pecking order for the major currencies? Amidst the summer stupor, it just might be the case that we witnessing a change in the pecking order amongst the major currencies. In the first half of the year, the trade-du-jour was to sell the euro against a basket of majors that included the Aussie, the pound and the dollar. However, the tide may be turning, and for the month to date we have witnessed some closing out of these short euro/long AUD-USD-sterling positions. So far in August, the euro has made very decent gains against the Aussie and against the dollar and sterling. An early call perhaps, but worth observing, if only because both investors and traders are very vulnerable should the price action experienced so far this month continue.

The Aussie’s structural vulnerability.  One of the more persuasive arguments put forward by those with a bearish disposition towards the Aussie dollar is that the combination of weakening global demand and excess capacity will continue to weigh on industrial commodity prices. The latest earnings results from mining giants such as BHP Billiton, Xstrata and Rio Tinto confirm that faltering demand has weighed heavily on profits over the past year. As a result, most big miners have pulled on the hand-brake on major mining projects down under. For example, BHP has postponed approval of the massive Olympic Dam copper, gold and uranium mining project (worth an estimated USD 33bn) and an iron-ore port expansion in Western Australia. Yesterday’s WSJ ran a lengthy piece making the case that Australia’s resource boom is running out of steam. In particular, demand from China for both coal and iron ore has slowed alarmingly. Both the Australian government and the RBA have made mention of a AUD 500bn pipeline of mining and resource projects, although perhaps one-half of these projects do not yet have funding and/or are awaiting approval from company bosses/regulators. Already, some mining companies are reducing headcount and spending amidst not just softer demand but also falling prices and rising costs. In China, both iron ore and steel prices have been declining sharply in recent months in response to accumulating stockpiles on the mainland. Coal stocks have soared by 48% over the past year and are now at a 4yr high. Chinese steel mills have been deferring their buying orders as they attempt to clear these stockpiles. In response, the coal price has collapsed by one-quarter in just two months. Also, the price of iron ore exports from Australia to China has plunged 20% over the past five weeks and by 38% in the past year. This combination of rising costs and falling prices spells trouble for the currency and the economy, which over recent years has benefitted tremendously from an improving terms-of-trade (the ratio of export prices to import prices). Australia is very responsive to changes in the terms-of-trade. As the latter declines, this will have adverse consequences for national income, an additional burden for an economy already struggling with an over-indebted household sector and a reluctant consumer. For the currency, a deteriorating terms-of-trade represents a significant structural vulnerability over the medium term.