Australian dollar headed for “benign collapse”

Deutsche Bank has produced a study into the Australian dollar with which I completely agree as a base case for the currency and economy:

As a house DB expects the RBA to be on hold over 2014, 2015 and H1-2016. In the US we expect the Fed to start increasing the Fed Funds rate around mid-2015.

Somewhat related to the latter point we also expect a general strengthening in the USD over the coming years.

The sum of these views presents us with a somewhat dramatic conclusion for AUD/USD. Namely that it could be trading with a ‘6 handle’ – in fact well into the 60’s come end-2015.

Critically, we would view this as a benign ‘collapse’ in the AUD; not one sparked by a domestic or offshore ‘crisis’. Of course that won’t stop people constructing bearish China scenarios, or continuing to claim that Australian housing is a ‘bubble’. (That latter claim is, we think, now entering its tenth year…)

Our point instead is that a much lower AUD should be considered a ‘base case’ and reflective of a ‘central forecast’; not some ‘tail risk’ event.

Indeed, should the world pan out as DB expects, AUD weakness over coming years could ultimately prove to be an important element in managing the headwinds faced by Australia as the mining boom ebbs.

…Over the near-term, however, (i.e. over the next few months) we remain of the view that the risks to the AUD are to the upside, with the labour market likely to strengthen.

The key to Deutsche’s forecast is a forecast narrowing in the US/Australia bond spread and thus collapse of the carry trade:

scs

A few points to add:

  • readers will recognise this as one of MB’s “five drivers” of Australian dollar valuation. That it is very important tells you that the RBA could have reduced the dollar any time it liked had it compressed this spread via macroprudential reform;
  • the risks of the very obvious housing bubble (its duration is only matched by the evolving distortions to the political-economy needed to keep it inflated) and/or a China hard landing would mean a malevolent collapse of the dollar. But that is the tail risk.
  • other than these points, Deutsche is spot on.

Comments

  1. Indeed, should the world pan out as DB expects MAYBE JUST MAYBE DB wouldn’t need to get bailed out!!!! Roh-ruh.

    AUDUSD .8983 and rising

      • Well, awesome Stevens fundamentally jumped the gun and ‘switched to neutral’. I don’t know if he was scared of capital flight or inflation but he has well and truly busted that jawbone now. If he ever wants to move the needle again, it’ll cost him.
        Meanwhile, America has been frozen.
        The AUD pause in decline has been fairly benign… ZAR and TRY have fared better and bounced right back.
        Once the american data switches from negative to neutral and the taper-taper trade fades, we can go back to shorting all the EM’s (Australia included) That’s my guess.

      • Exactly Dave, a cursory glance at the AUDUSD chart above (the one that shows the blue line diving under 80c) shows you that the ramp over 80 into parity+ was driven by liquidity. Am I supposed to believe that liquidity is going away any time soon? And am I supposed to believe this from DB who couldn’t possibly have gotten the moves in EUR more wrong? I don’t!

      • @Dave for 1/2 hour sure! We’ve already seen this film June/July/August last year as SHIBOR was locking up.

        EDIT: Which incidentally is when the fun shorting AUD was really to be had! Shorting FMG then was like printing money too but then it all turned around rather quickly and I spent the better part of 4 months losing money/puts trying to fight the liquidity trap. Failed.

  2. “..we also expect a general strengthening in the USD over the coming years.” Why on earth would the USA allow, or even want, that given the effort is has put into devaluing its currency in the name of domestic competitiveness/export re-orientation? What does DB think the USA unemployment rate would look like at higher US$ levels? Lower?!

    • DB thinks that’s the world panning out like it expects. Just like all those FX swaps on its books will all come in rich one day…

    • 7.25 USD minimum wage.
      At a certain point, competing with emerging markets for factories has to be balanced against the outright fight against poverty. They’re there.
      (Recently read about several companies bringing their factories back to the US from china – cheaper)
      If anyone could afford a stronger currency, its them.

  3. Grouse – a weakening AUD as measured against a weakening USD. Gold in AUD terms would look fantastic…

  4. A benign collapse into the 60s would be the best outcome for all Australians, even miners. Mind you, it will have to stay there for a long time before our trade-exposed sector becomes competitive again.

      • Needs to go a lot lower than 90c. Mid-70s for an extended period might do the trick, but sub-70c is when you’ll see exporters get interested again.

  5. Kinda hard to follow their logic.
    Unless IO and LNG completely collapse in 2015/16 Australia will transition to CAS (for the first time in 40 years). Couple this with a booming housing market and all the external currency inflow thats needed to support another 15% housing appreciation and there is no way the Aussie trades in the 60’s. Do these guys do real cashflow analysis or do they simply pull these numbers out of their A55’s

    Only way this makes sense to me is that Australia quickly enters a recession and housing prices collapse.

    • +1 to say nothing of the liquidity pump, as if Japan isn’t going to give it another red hot go any day now.

    • Strange Economics

      Yes – what about the hot Asian money flowing in to purchase most of Australian housing. (whats left after the SMSFs and the negative gearers). Considering 20 % of Melbourne property sells to foreign money –
      20 % of houses sold each year in the capitals is 100,000 houses with 200k invested in each from foreign money per year ? -> 20 billion a year currency in…..

  6. Who can you trust……?

    Waiting at pier 618 with my net to catch AUD

    Hoping to catch some big ones and fatten them over time for a kill @ parity….

      • Just to put things in perspective, SPX500 Commercial position net short:

        7/1/14 – 62,536 contracts
        25/2/14 – 11,096 contracts

        trend and position point to short term dip but base is set to support uptrend……

        The biggest players have backed their conviction with $$$…. lets see how the Soros’ short plays out!