Westpac: Australian dollar to drop to 0.68 cents

Via Westpac’s March update:

It has been an eventful month for the Australian economy, with GDP and other key data surprising to the downside, and interest rate expectations shifting. Regardless, at USD0.7079, the Australian dollar is effectively unchanged from USD0.7093 when our February Market Outlook went to print, having held a fairly tight range of USD0.7009 to USD0.7183 since.

The detail of the December National Accounts is laid out on page 8. With respect to the currency, all that needs to be stated is that from a 4% annualised pace in the first half of 2018, GDP growth slowed to just 1% annualised in the second. On the back of this dramatic deceleration, and given our concerns around the effect of declining house prices and soft household income growth on consumption, we look for growth to remain materially below trend at 2.2%yr in both 2019 and 2020. Versus the US, relative growth comparisons will then remain a material headwind for the Australian dollar over the forecast period.

A consequence of Australia’s weak economic growth and the skew of global risks is a need for further monetary policy easing by the RBA. We believe this is most likely to take the form of two 25bp cash rate cuts in 2019 – the first delivered in August, the second come November.

If we are also correct in forecasting one final rate hike for this cycle from the US FOMC, then by end-2019, the policy rate differential between Australia and the US would stretch to –163bps – a highly-abnormal spread versus history. Albeit at the whim of the market, such a policy outturn should also see the Australia/US 10-year yield spread widen from –57bps currently to nearer –90bps through mid-2019, after which it will likely remain historically wide as both the RBA and FOMC go on hold in 2020 (a spread of –65bps is expected at end-2020).

Against the scale of the above Australia/ US differentials for growth and interest rates, our forecast for less than a 4% decline (circa 2.5 cents) in the Australian dollar to USD0.68 in the second half of 2019 appears modest. The justification for maintaining this forecast is two-fold: (1) key commodity prices continue to hold up better than anticipated; and (2) demand for Australian assets from foreign investors remains very strong.

For Australia, iron ore and coal prices remain key. Over the past year, both markets have seen significant supply disruptions and a seeming unwillingness (or inability) of producers to quickly offset the production loss. Coupled with ongoing structural reform (which preferences highquality inputs) and strengthening construction-related demand for steel in China, impaired supply has resulted in elevated price levels for both iron ore and metallurgical coal, respectively US$87/t and US$183/t. In terms of the expected return for miners from current production and broader sentiment for the Australian dollar, this is a clear positive.

While we anticipate a pull-back in prices through 2019 and 2020 (to US$75/t end-2019 and US$65/t end-2020 for iron ore; and to US$150/t end-2019 and US$135/t end-2020 for metallurgical coal), the pace of decline will be measured as supply takes time to correct. For Australian dollar demand, it also seems probable that some of this decline in unit prices will be offset by higher volumes over the forecast horizon. All of this considered, we believe the Australian dollar will gradually edge back up from USD0.68 end-2019 to USD0.70 at end-2020.

Extending our analysis from trade receipt flows to investment/capital flows, it becomes apparent that the Australian dollar will likely receive additional support in the near term. In recent months, Australian resource companies have actioned a number of capital management strategies to return excess cash to investors, ahead of potential changes to franking credit rules after the coming Federal election, and given a limited need for capital for capacity expansion. As a large portion of the share registers of these firms are domiciled in Australia, this has provided persistent support for the Australian dollar which could last to the end of FY2019.

More broadly, as at December 2018, it was evident from the ABS Balance of Payments release that foreign investor demand for Australian assets remains very strong. Of particular note, direct investment flows (defined as a 10%+ stake in a company) amounted to $76bn in 2018, almost one and a half times the seven-year average back to 2011 – already a historically strong period for direct investment flows. Whereas during the mining investment boom, direct capital was used to fund new real economy investment, currently it is more a result of foreign investors’ desire for existing income-yielding assets in Australia. This demand is also evident in portfolio inflows into Australian debt securities, which at $74bn was also robust in 2018.

While support from these yield-seeking flows will persist, given the global backdrop and Australia’s growth outlook, it seems inevitable that they will moderate hence. Ergo, the ability for the Australian dollar to maintain or exceed the USD0.70 figure is only likely to remain until mid-2019 after which the above growth; interest rate; and commodity dynamics will re-assert.

Comments

  1. One take from that if AUD remains strong in the face of a slowing economy, falling property prices etc
    I think the current falls in resi property will only be exacerbated without the cushion of a falling dollsr
    The strength of the AUD in a slowing economy will limit the rise in ASX too.
    Somehow they really should find a way to lower the AUD to 60/65c to help offset the pain ahead

  2. All I can see is long Aussie bonds, USD in bank pays 2.2%on monthly TD and cash in bank at 2% around
    Just get your money out of thd bank before the 4 banks blow sky high and are closed for a week to take half your deposits

    • proofreadersMEMBER

      Might be an idea if the RBA concentrated on the hot money books of the Strayan banks, than drifting in to climate science for an attempt at relevance?

  3. On any fundamental Labour net Productivity analysis basis the AUD belongs at sub $0.30 yet here we are again at $0.70 or thereabouts yet few ask why. What are these forces that maintain an overvalued AUD?
    As I’ve said before it all comes down to making your choice at the ugliest whore house in the world where abstaining is not an option. In the end the flow of capital is way more important than the flow of goods / services in determining the exchange rate but that’s good news for those that accept this and bad news for those that delusional Keynesian’s who still believe exchange rates to be the invisible hand that balances labour productivity around the globe.

    • The unfettered flow of inward investment buying up our assets (and bonds) to take the income streams offshore is the very definition of national stupidity.

      We sell off everything, lose control of the assets and the revenues so we can prop up the dollar and delude ourselves we’re still a rich nation.

      How long does it take to boil a frog when you start with cold water?

      • The unfettered flow of inward investment buying up our assets (and bonds) to take the income streams offshore is the very definition of national stupidity.
        Some what playing devils advocate but Why is this national stupidity?
        What real harm has been done to our nation through 50 plus years of importing capital to meet our needs?
        Is the average Australian materially better off or worse off than their grand-parents?

        Personally I believe that we as a nation benefited from this flow of capital for a long time but we’re way past the point of benefit and now do it out of necessity. So we’re like the drug addict that liked a taste when they were young but now shots-up because they can’t survive without the drug, this is a bad situation to be in and not surprisingly it’s a situation that others take full advantage of.
        Like any drug addiction the first step towards recovery is acknowledging that you have a problem, unfortunately we’re not there yet as a nation. we probably need to go through a couple of Argentina style cold-turkey withdrawals before we’re ready to acknowledge our problem.

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