The Australian Dollar is a Buy says Goldman Sachs

Goldman Sachs headquarters, New York. © Ludovic Bertron

- AUD to outperform EUR in 2019 says Goldman Sachs.

- China will stabilise and the RBA could hike, lifting AUD. 

- Betting on AUD/EUR cheapest way to trade AUD rebound.

The Australian Dollar shifted onto its back foot in the final session of the week after failing to hold an earlier two-month high, but the 2019 year ahead will be kinder to the currency than 2018 according to analysts at Goldman Sachs.

Goldman Sachs' analysts are advocating that clients of the bank buy the Antipodean unit ahead of the 2019 year, in anticipation of a recovery in developing world financial markets and a pickup in the Chinese economy. 

"Despite strong domestic fundamentals, AUD has weakened in lockstep with other EM assets this year against a backdrop of China slowdown concerns," says Kamakshaya Trivedi, global co-head of foreign exchange at Goldman Sachs, in a report detailing the bank's best trade ideas for next year.

Even after a fortnight close to the top of the G10 currency performance table, the Australian Dollar has been left nursing what is still a 7.1% loss against the U.S. greenback for 2018, and a 2.1% decline against a Brexit-stricken Pound.

It's fallen by only 1.7% relative to the Euro but buying the AUD/EUR rate is a top trade for 2019 because political risk and European Central Bank (ECB) interest rate policy are likely to "cap" the single currency during the months ahead. 

In other words, if the bet does not work out, the downside is lower for those buying AUD/EUR than it might be when trading other Australian Dollar pairs.

"We think there is room for a rebound," Trivedi writes. "We recommend funding the trade out of EUR, where a confluence of political risks and growth concerns is likely to cap performance over the next few months and carry is attractive."  

It is cheaper to "fund" bets on AUD/EUR than to finance wagers on other Aussie Dollar rates because the ECB's interest rates are still among the lowest in the world, so investors aren't really forgoing anything by betting against the Euro. 

However, the Aussie has been badly damaged in 2018 by the latest evolution of the global interest rate environment and by President Donald Trump's so-called "trade war" with China. 

The Chinese economy is creaking beneath the weight of $250 billion of 10% tariffs on goods exported to the U.S. each year, despite China's efforts to offset the impact with its own retaliatory measures.

"We expect him to raise the tariff rate on the $200bn tranche to 25%, as already scheduled for January, and also view a 10% tariff on the remaining $267bn of imports from China as more likely than not," says Trivedi. 

Industrial production, fixed asset investment and GDP growth have all slowed in 2018. Goldman forecasts full-year Chinese GDP growth will slow from 6.9% in 2017 to 6.6% for 2018 and that it decline further to 6.2% in 2019. 

However, and despite an anticipated escalation in the trade war early next year, 2019 is seen by Goldman as likely to mark a nadir for Chinese growth.

When this is combined with forecasts for an eagerly-awaited interest rate rise in Australia, the outlook for the Aussie Dollar appears brighter.

"Our forecasts imply a fairly broad-based turn to higher rates across most DM economies, with Sweden, Australia, New Zealand, and (in our baseline forecast) the Euro area joining the US, UK, Canada, and Norway in lifting their policy rates," says Trivedi. 

The Reserve Bank of Australia (RBA) continues to indicate it will hold its cash rate at a record low of 1.5% until well into the 2020 year, while other central banks are working toward "normalising" their rate structures. 

In most cases this has reduced the positive yield differential between Australian and other government bonds, although the gap between yields down under and those in the U.S. and Canada now tilts firmly against the Aussie currency. 

In other words there is at best a diminishing incentive, and in some cases a disincentive, for investors to hold Australian Dollar assets instead of others. 

That explains not only 2018's losses, but also why the Aussie Dollar could have scope to outperform next year if and when the RBA eventually suggests it is gearing up to raise rates. 

The AUD/EUR rate was quoted 0.26% lower at 0.6402 Friday. AUD/USD was down 0.15% at 0.7262 and is currently 7% lower for 2018. The Pound-to-Aussie rate was 0.72% higher at 1.7681 and is up 2.5% for 2018. 

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