Key View We are bearish on the Australian dollar over the near term due to a neutral RBA, growing US-Australia yield differentials, and global and political uncertainties. However, we believe that the unit will stabilise over the longer term as we expect the RBA to turn hawkish in the latter half of 2019 which would support a narrowing of yield differentials with the US. Furthermore, the currency’s undervaluation should also support some AUD strength. Short-Term Outlook (three-to-six months) The Australian dollar has depreciated by 4.1% against the USD since our previous forecast in July in line with our expectations. We remain bearish on the unit’s trend in the near term and we are revising our forecast for the pair to average USD0.7450/AUD in 2018, ending the year around USD0.7000/AUD. First, the Reserve Bank of Australia (RBA) appears likely to remain on a neutral stance through 2018 to keep the currency competitive. Despite AUD’s slide against the USD, the currency’s strength remains relatively stable (if not only slightly weaker than its 10-year average) on a trade-weighted basis. This implies that the central bank is unlikely to raise interest rates to support the currency in the near term.
Second, the central bank keeping its policy rate on hold in the near-term will likely result in a further widening yield differential with the US, as the US Federal Reserve is undergoing a rate hiking cycle. We only expect a 25bps rate hike from the RBA by end-2019, in contrast with 100bps worth of hikes from the US Fed over the same period. We expect the widening yield spread to weigh on the demand for Australian debt securities, relative to the US, thereby putting downside pressure on the AUD.
Third, the AUD’s performance tends to be positively correlated with risk-on sentiment. Given that escalating global trade tensions between China and the US (Australia’s largest and 7th largest export destination, respectively) will be negative for global growth as a whole, this would bode poorly for global risk sentiment, and consequently the AUD. Finally, Australia’s ruling Liberal-National coalition has lost its majority in the House of Representatives following the Wentworth division by-election on October 20, which saw the Liberal Party lose the seat for the first time since 1944. We expect the (now) minority government to face increased difficulty in the policymaking process over the coming months, given that government is likely to adopt a more open stance toward policy compromise with the other parties in a bid to shore up support on the ground. The decline in support for the coalition will likely also result in political uncertainty through most of 2019, which will likely put downside pressure on the AUD. Long-Term Outlook (six-to-24 months) We believe that most of the decline is behind us and we expect the Australian dollar to stabilise over the longer term, and we are revising our forecast for the unit to average USD0.6900/AUD in 2019 (from USD0.7400/AUD previously). Our view is driven by the following reasons. We expect the RBA to turn hawkish in the latter half of 2019. The central bank aims to achieve its goals of maintaining currency stability, full employment, and the economic prosperity and welfare of the Australia people, through targeting inflation between 2.0-3.0% over the medium term. While currency stability has not been too much of a concern for the RBA, the achievement of its medium term full employment and real GDP growth target appears to be steering its policy decisions alongside the inflation print.
Unemployment has fallen to 5.0% in September, the level which the RBA has been targeting based on its monetary policy statements. Real GDP growth also picked up to 3.4% y-o-y in Q218, from 3.2% y-o-y in Q118 and we forecast growth to average 3.0% for 2018, close to RBA’s target ‘a bit above 3%’ for the year. Although we forecast growth to slow to 2.5% in 2019 alongside global growth, we wish to highlight that risks to our forecast are weighted to the upside. Should growth firm and surprise to the upside around 3.0% in 2019, this would provide more reason for the RBA to raise interest rates. In particular, we believe that inflation could pick up faster in 2019 and we forecast inflation to print at 2.4% in 2019, up from 2.1% in 2018, due to higher oil prices over the coming quarters.
Moreover, the currency’s real effective exchange rate also appears to be below its 10-year average. This suggests that the currency is slightly undervalued, and given the tendency for currencies to mean revert towards their long-term averages, this would point toward a slight strengthening of the AUD of the longer term. Risk to our currency forecasts are evenly balanced. On the upside, further monetary and fiscal stimulus by the Chinese government could strengthen demand for industrial commodities, which would well for the AUD. On the downside, although unemployment looks to be on track to hit the RBA’s target, the improved reading was due to both a rise in employment and a fall in the labour participation rate. This could prompt the RBA to remain on hold for longer so as to provide support to the labour market, which would delay our outlook for monetary policy to provide support to the AUD.
Lordy that is poor analysis:
core inflation is below the RBA band;
underemployment is now the key measure for labour market slack and wages growth;
nobody uses a 10 year average for fair currency value, and
RBA to hike next year just as Sydney house prices falls pass through -12%?
If the AUD is going to keep falling until the next RBA hike then it’s going to zero.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
