Australian Dollar Forecasts 2014: Bank of America Re-Callibrate AUD Predictions

Analysts from Bank of America Merrill Lynch Global Research have spent a week in Australia, visiting three cities and a range of investors including hedge funds, real money investors, corporates and officials.

The trip allowed them the opportunity to calibrate their forecasts for the Australian dollar in 2014 with the team noting that by far, the biggest topic of discussion was the AUD’s resilience amid the collapse in iron ore prices and weak China data during the week.

Below are snippets from a research article produced by analysts Adarsh Sinha and Bin Gao in the wake of their visit:

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Aus dollar forecasts 2014

Investors see Australian to US dollar exchange rate above 0.90 in 2014

"A significant number of domestic investors are backing the Australian to US dollar exchange rate to remain above 0.90 in 2014."

Aus Dollar not sensitive to copper and iron ore prices

Research shows the Aus Dollar is in fact NOT sensitive to short-term swings in iron ore prices and even less so to copper prices.

"Copper prices, they simply do not matter for AUD dynamics. Copper exports are less than 2% of Australia’s overall exports so have little impact on the terms of trade."

AUD resilience, Factor 1

Increasing optimism on the domestic economy

"On balance, a surprising majority of investors we met were bullish and expected the next RBA move to be a hike (most likely in 1H15). Indeed, several investors felt that the market would be forced to price in a greater risk of rate hikes if 1Q inflation data surprised higher in April."

AUD resilience, Factor 2

Improvement in trade balance

"While export growth will be sensitive to underlying demand from China, in the absence of a collapse in Chinese steel production, Australia is still likely to post a full-year surplus in 2014 as more resource projects come online and ramp up exports."

AUD resilience, Factor 3

Foreign purchases of AU government bonds

"In our view, foreign central bank reserve accumulation and rebalancing has supported the AUD."

AUD resilience, Factor 4

Mining capital inflows

"While difficult to track on a real-time basis, especially since much of the financing is done internally, the fact that LNG project investment will remain at a high level during most of 2014 makes it reasonable to expect these inflows to persist for a while longer."

Forecast for 2014 and 2015

Resilience will offer opportunity to sell AUD

"We remain comfortable with our conservative year-end forecast of 0.88 for AUD/USD, primarily based on the balance of payments dynamics discussed above – but we expect a more precipitous fall to 0.80 in 2015.

"However, there is a near-term risk of a squeeze higher in the AUD if the domestic data stay strong and the consensus shifts further in favour of RBA tightening.

"If this transpires, we would recommend using this opportunity to set medium-term shorts in AUD: our economists remain negative on economic prospects in the second half of 2014 and the RBA’s tolerance for exchange rate appreciation toward 0.95 is likely to be limited.

"We continue to view long-dated volatility in AUD/USD as an attractive level to buy vega or express a long-term directional bearish view, in line with our Year Ahead recommendation.

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