Does Australia pay too much attention to the state of the US economy?

The controversy-ridden US election campaign has local businesses asking how important is the US economy to Australia's fortunes?

After a fractious US election campaign, governments and businesses are reassessing how the US economy will interact with the rest of the world.

So, how important is the US economy to Australia?

Su-Lin Ong

Managing director, chief economist and head of Australian research at RBC Capital Markets

Su-Lin OngThe health of the US economy has important implications for Australia through several key channels.

Firstly, the US is Australia’s third-largest trading partner. While it may get overlooked as China and Asia dominate discussions around Australia’s exports and potential, trade in goods and services with the US is worth about 4 per cent of GDP per year. In terms of financial flows, the US is also our largest foreign investor.

Secondly, Australia is a small and open economy that is highly leveraged to the global growth and commodity cycle. As the world’s largest economy, the US remains a key driver of the direction and trend of world growth.

Indeed, despite the continued sluggish pace of global growth eight years after the global financial crisis, world growth would be far weaker without the contribution of the US economy; the US was the fastest-growing G7 economy in 2015.

Related: The story behind China's two-speed economy

Thirdly, global financial markets and sentiment are more intertwined than ever. Movements in US treasuries transmit quickly through to Australian bond yields, especially in the mid to longer part of the curve. The setting of the US Fed funds rate also has some implications for the domestic cash rate as yield differentials influence the currency.

“As the world’s largest economy, the US remains a key driver of the direction and trend of world growth.” Su-Lin Ong

Investors are chasing higher yielding markets as US and global yields move ever lower, and Australia has been a magnet for these funds, which have partly underpinned a stronger A$ than desired. This has kept pressure on the Reserve Bank of Australia to cut rates to historic low levels.

So keep watching the US economy; it affects you more than you realise.

Leon Berkelmans

Director of the International Economy Program at the Lowy Institute

Leon BerkrlmansTwenty years ago, it was said that if the US economy sneezed, Australia caught a cold.

The seeming dependence of Australia upon fluctuations in the US was indeed extraordinary. In their models of the Australian economy, economists within the official family only bothered to include US GDP – no other measure of foreign activity was viewed as necessary.

However, things changed. The US experienced two recessions in the noughties that didn’t cause bedlam Down Under. We’ve also seen the China boom. China rapidly swamped all comers to be our largest export market, and the correlation between the Australian and Chinese economies shot up. But that correlation has waned of late, and US primacy has been restored.

These are the facts. Interpretations of the facts are more difficult.

The high correlation with the US economy was always hard to explain. Trade wasn’t big enough to do it. Was it asset and capital markets then? Maybe – who knows?

Experience has shown that if the US enters a rough patch, we are now not destined to follow. I think the same is true for China – the Australian floating exchange rate provides a wonderful shock absorber, and financial linkages between Australia and China are thin.

“If the US enters a rough patch, we are now not destined to follow.” Leon Berkelmans

Do we pay too much attention to the US? For short-term movements, perhaps. But the US is a powerful engine of the world’s ideas. If it retreats to become insular and protectionist, I reckon that engine will lose some of its horsepower, and that’s a problem.

Paul Bloxham

Chief economist at HSBC Australia and New Zealand

Paul BloxhamAustralian market observers pay significant attention to US economic developments. This makes sense, given that the US still dominates global economic news.

The local equity market often takes its lead from the US market and the US dollar is the currency most used in global trade and financial transactions.

The US dominates global financial markets despite the fact that China now has a larger economy than the US on some metrics and is the biggest contributor to global growth.

Chinese financial markets are developing rapidly, but the process still has a long way to run. It is likely that it will still be many years before China’s financial instruments are tracked with the same sort of keen interest as the US dollar, US treasuries or the S&P500.

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Of course, for Australia, developments in Asian financial markets, and particularly in China, are increasingly important. China is Australia’s single largest trading partner and plays a dominant role in commodity markets. As a result, developments in China drive commodity prices, which in turn heavily affect the profitability of the mining sector and movements in the Australian dollar.

China is driving much of the growth in Australia’s services exports, including tourism, education and business services. China is also an increasing driver of capital inflows to Australia, although the largest stock of investment is still from Western markets, led by the US.

So, while you should continue to keep an eye on the US, don’t forget to start building the skills for tracking China’s markets. You’re going to need them.

The experts

Su-Lin Ong

Su-Lin Ong is managing director of RBC Capital Markets and head of economics and fixed income strategy for Australia and New Zealand. Based in Sydney, she is part of the global strategy team, with primary responsibility for formulating and presenting RBC’s Australia and New Zealand macroeconomic outlook and supporting capital markets operations in Australia, Toronto, New York, London, Tokyo and Hong Kong.

Prior to joining RBC in 1998, Ong was a fixed income economist for Hambros Bank and before that worked as an economic adviser at Australia’s Department of Prime Minister and Cabinet.

Leon Berkelmans

Leon Berkelmans is the director of the International Economy Program and the G20 Studies Centre at the Lowy Institute. Before joining the institute, Berkelmans was a senior manager at the Reserve Bank of Australia (RBA), where he worked on the Chinese and Indian economies, investment, trade and financial markets.

Prior to the RBA, he worked at the Federal Reserve Board of Governors in Washington D.C., where his main responsibilities were macro-econometric modelling of the US economy.

Paul Bloxham

Paul Bloxham is chief economist for HSBC in Australia and New Zealand. He is HSBC’s chief spokesperson on forecasts and trends for the Australian and New Zealand economies and their interaction with global financial markets and international economies. Before joining HSBC in 2010, Bloxham spent 12 years as an economist at the Reserve Bank of Australia. He is an adjunct professor at Curtin University.


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