Goldman lifts Australian dollar outlook. Ignore it

See the latest Australian dollar analysis here:

Macro Morning

Via Forexlive:

    • GS expect RBA to remain on hold, as economy is staying resilient despite house market issues
    • Australia to benefit from improving market sentiment on the Chinese economy (stimulus coming through, also potential for resolution of trade tensions with the US)

Forecasts from the bank AUD/USD:

    • three month 0.74
    • six months 0.75
    • from 0.72 and 0.73 respectively the prior call

Past performance is no indicator of future but Goldman has been far too bullish in the Aussie economy and interest rates throughout this late cycle period of higher commodity prices. Here’s what it forecast in January for the Aussie 10 year:

Instead of rising, the 10 year yield sank to 1.76%. The outlook further out was and is a joke.

If we look back further, in late 2017 it was beating the same drum:

Goldman Sachs is tipping the official cash rate in Australia could hit 2 per cent by end-June 2018 (from 1.5 per cent currently), although the brokerage has pushed back its forecast for the start of a tightening cycle by 3 months to May 2018.

Goldman Sachs acknowledges its forecast path for the cash rate “is at the hawkish end of consensus expectations” in predicting a 50 basis points rise through the financial year, even though it implies accommodative policy settings all the way through to 2021 when it expects the RBA to return the cash rate to the central “neutral” estimate of 3.5 per cent.

Goldman points out “positive inflection points are evident across Australia’s macroeconomic data” and “in many respects the growth outlook has not been this upbeat for around five years”.

In fact, it began in late 2016:

  • A sharp turn in Australia’s national income dynamic, which we flagged in early August, now looks likely to move significantly higher following the spikes in coal and iron ore prices in the closing months of 2016. Although we expect prices to fall from current levels for these commodities, the recent surge transforms our expectation for a modest rise in Australia’s terms of trade in 2017 to a material 8% gain with most of the export price spike to be registered in late 2016 an early 2017. This is likely to set off a chain of events through the Australian economy in coming months. The resulting surge in national income should be reflected via much stronger mining profits, a large taxation windfall for the Federal government (and elimination of the threat of a sovereign downgrade), a restarting of idle capacity in the coal sector, a better climate for broader business investment and ultimately better employment and wage outcomes. It also sows the seeds for a more material handover of the economic growth baton to the private sector, and importantly this transition can proceed despite our forecast of a sharp decline in new dwelling investment in 2017-18. Perhaps the most dramatic transformation will come via Australia’s external accounts with a run of trade surpluses now in prospect for 2017 – indeed the combination stronger commodity prices and the ramp-up of LNG production suggests Australia will post the largest trade surpluses as a share of GDP during 2017 since any time since the early 1970s. Ultimately the state of the external accounts is the truth serum for the currency, and as such we acknowledge clear upside risk to the A$ from current levels.
  • How will the RBA respond? We continue to forecast that the RBA will commence increasing interest rates from 1Q18; however, the skew is now towards an earlier kick-off in 2H17. Much will depend upon the response of the A$ and other asset prices that we capture in our financial conditions index. Of particular interest is that since the 1 September our financial conditions index has moved from a contractionary setting into expansionary territory for the first time in over 12 months. The negative impact from rising bond yields has been more than offset by narrowing credit spreads and rising commodity prices. At this stage the Australian economy has ample spare capacity in product and labour markets and a low starting point for inflation. While this suggests the RBA has time on its side before recalibrating interest rate settings, the RBA’s focus has increasingly shifted under the stewardship of Governor Lowe towards minimizing risks in the financial cycle rather than just the economic cycle. On this score, the RBA may begin to question the rationale for keeping official interest rates at a record low of 1.5%. At this stage we have kept our forecast for the RBA to commence its hiking cycle in 1Q18 with the RBA forecast to increase interest rates 75bps through 2018 and a further 75bps spread over 2019 and 2020 to a 3.0% cash rate. Nevertheless, the risk of the RBA increasing the cash rate in 2H17 has risen materially and the evolution of financial conditions, house prices and underlying inflation will ultimately guide the decision.

Why has GS been so wrong? Because it expected the commodity income to flow through to the real economy. But in Australia’s Dutch Disease sickened economy that no longer happens because bulk commodity income mostly flows to the rich and the Budget, and LNG income actually drains wider economic income via skyrocketing utility prices.

GS could be right this time around, of course, but if so it’ll look a lot like a stopped clock.

David Llewellyn-Smith

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