Australian Dollar Forecast to Decline Back to the Late 0.60's
- Written by: Gary Howes
The Australian dollar took a knock on Tuesday after currency markets were reminded that the Chinese slowdown is still with us and the A$ is potentially overvalued.
The Australian dollar has advance over recent weeks tracking gains in global commodity prices confirming the tight correlation between the two asset classes.
Chinese trade data has seen commodity sensitive assets sell-off, exports were flat in year-on-year yuan terms which is a relatively decent performance all considered.
However, imports dropped a much-worse-than-expected 18% suggesting demand for Australian exports will take a hit.
There is more than enough space for the Australian dollar to decline from current levels as the exchange rate is now well ahead of Reserve Bank of Australia forecasts.
The RBA's Bill Evans notes:
"Our current forecast is for the Australian dollar to finish the year around $US0.68 and fall further to $US0.66 in the first quarter of 2016. It is currently around $US0.725 and is looking strong."
The reasons for a forecast decline in the AUD centre around the Federal Reserve; commodity prices and Australia’s chronic external deficit.
Thus, a decline in the Australian dollar exchange rate family are to be expected if the RBA is correct and we hear from a prominent analyst that now could be the time to chase the currency lower.
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So what will it take for the current aggressive rally in the A$ to start to turn around, and at what level will speculators and corporates look to hedge or sell the A$?
"I have stuck with the view that the A$ would be 'sticky' in the late 0.60's/ very early 0.70's. Late August I argued there was a long list of factors that were likely to prevent the A$ from spending much time below 0.70," says analyst Rob Rennie at Westpac in Sydney who sees AUD downside in his crystal ball.
Rennie cites the following factors:
- The RBA’s shift in A$ guidance
- Market pricing for the Fed
- Iron ore remaining stable above $55
- Japanese demand continuing
- Increased A$ bond issuance
- The upcoming 20yr bond future
- Increased M&A activity
"To varying degrees, these factors are still present. The RBA reaffirmed its 'neutral guidance' on the A$ last week saying, 'the Australian dollar is adjusting to the significant declines in key commodity prices' after the shift from 'further depreciation seems both likely and necessary' in August," argues Rennie.
Current market pricing for the Fed has reverted back to not fully pricing in one rate hike over the next 6 months. And iron ore remains pretty stable around the $55 level.
Commodity markets saw an aggressive positive shift in market sentiment helped by Glencore's announcement on output cutbacks, and Chinese markets showed resilience as they opened up after the week long holiday.
Rennie argues we could yet see further Australian dollar upside from here: "In the short term, I can see AUD up to 0.7380 (38.2% retracement of the May high to August low), possibly 0.7410/20 (the top of the downtrend from the September high last year and May high this year)."
But beyond that, Rennie remains confident in the RBA's view i.e. that markets are complacent on the Fed; that the outlook for iron ore prices will deteriorate as additional supply comes onstream in coming weeks; and that the chronic trade deficit will all help to undermine the A$ into the end of the year.
"So as we approach 0.7380/ 0.7420 I will be increasingly arguing to hedge or to sell AUD at levels that we would be most surprised to see persist into 2016," says Rennie.
Latest ANZ Forecasts See Lower AUD
ANZ have meanwhile confirmed they see the Australian / US dollar exchange rate falling from current levels over to achieve a lower level by year end:
"The AUD's recent recovery has come alongside a smart recovery in Asian EM currencies and a generally softer US dollar this far in October.
"We continue to forecast 70 cents for year-end, partly in anticipation of renewed market volatility out of the 17 Dec FOMC - whatever the outcome."
Commodity Prices: The Troubles Are Not Yet Over
For the New Zealand, Australian and Canadian dollars the movement of commodity prices remain central to their outlooks.
In short, should the downtrend in commodity prices resume you can expect the end of the rallies on the dollar complex.
Copper and oil prices have rebounded and numerous senior industry figures talked of the worst now being over.
“We agree that the downside price risks are receding as supply restructuring is gathering pace, but the bottoming out process is likely to last for a while yet,” say Barclays in their Commodity Weekly brief to clients.
If past patterns are any guide, Barclays argue, there is unlikely to be a sustainable improvement in the prices of either commodities until global GDP starts to improve and there is little sign of that yet.
RBA's Lowe: There are Reasons to be Positive
It's not all doom-and-gloom for the aussie though as RBA Deputy Governor Philip Lowe strikes an optimistic tone noting that the Bank retains flexibility on interest rates.
He emphasised that Australia’s economic fundamentals were good and the economy has high degree of flexibility at the CFA Institute Australia Investment Conference in Sydney.
Most of Dr Lowe’s remarks focused on the microeconomic reform agenda that would lift Australia’s living standard over the medium term, and so he did not directly address the near term path for interest rates in his speech.
Lowe said business conditions were above average overall and that business was reporting that current conditions are ok.
He said firms were willing to hire and as they have stated many times before, it is not clear at what point this will translate into higher capex.
