Via Bill Evans at Westpac:
Westpac Economics has long argued that the Australian dollar will move lower during 2019 and 2020. There has been evidence of this recently, particularly over the past month, against the backdrop of heightened global volatility as the trade war escalated.
Having traded in a range of around USD0.70-0.72 through 2019, the Australian dollar extended below USD0.70 in May and then from mid-July to early August slumped from USD0.708 to below USD0.67, making fresh post-GFC lows. In the last few days it has subsequently rebounded to 0.68. We continue to expect the Australian dollar to trend towards a low of USD0.66 by the fi rst half of 2020, and to hold near that level in the second half of the year, circa USD0.67.
Shaping our view on the Australian dollar are the key fundamentals of interest rate diff erentials with the US and commodity prices, as well as the broader global economic backdrop and associated ‘risk-on’, ‘risk-off ’ sentiment.
Beginning with interest rate diff erentials, at its July meeting, the FOMC cut the federal funds rate by 25bps, as widely anticipated. This was billed by the Committee as the beginning of a “midcycle adjustment” of policy “not the start of a long series of cuts”.
Just a day later however, President Trump’s decision to impose a new 10% tariff on the $300bn of Chinese imports to the US which had previously been unaffected by the trade war cast considerable doubt on this view, all the more so as President Trump made clear that the tariff rate could increase to 25% or more.
President Trump’s decision has two key implications: the $300bn of goods so far unaff ected are essentially direct consumer goods, indicating an unexpected negative shock to household budgets. Secondly, the development signifi cantly raises the intensity of the trade war with negative implications for world growth, global manufacturing and business investment.
These developments will make necessary signifi cant changes to the FOMC’s assessment of the outlook and associated risks, particularly given US growth was already slowing.
Previously we had sided with the FOMC, anticipating that two cuts (including July’s decision) would be enough to sustain GDP growth at trend in 2019 and 2020. Now however, with a lower expected profi le for US investment, employment, confi dence and therefore consumption, we believe the FOMC can no longer lean on merely a “mid-cycle adjustment” if growth is to be held near trend. Instead, the best policy approach in these circumstances is clearly to use some of their existing policy flexibility to ‘get ahead of the curve’.
This outlook implies that the FOMC is now likely to cut at every meeting through to the end of 2019, in September, October and December, taking the fed funds rate to 1.375%.
Looking to 2020, a Presidential election year off ers scope for further fi scal support and, with the FOMC laying the foundation of a rate structure which is well below neutral and therefore stimulatory, we are comfortable to assume some rate stability in 2020. That being said, it is diffi cult to foresee global uncertainties abating over the period, so the risk of further easing will remain.
In terms of sentiment, a marked deterioration in global confi dence and trade is likely to continue to see investors favour safe-haven currencies over the coming year, specifi cally the Yen and US dollar at the expense of pro-cyclical currencies such as the Australian dollar.
Further weakness in the Australian dollar is also justified by recent and expected commodity price developments. Prices for iron ore and coal moved sharply lower during July and early August amid global uncertainties. Ahead, while a period of stability to year end is anticipated, come 2020 a further decline for 62%fe iron ore is forecast, from US$98/t to US$65/t as supply improves, demand softens, and global risks linger. Met coal prices are also expected to fall through 2020, from US$150/t to US$135/t, while thermal coal is seen little changed at US$65/t.
Taken together, interest rate differentials, global risk sentiment, and commodity prices collectively continue to justify our long-held view that the Australian dollar will fall to USD0.66 in the first half of 2020. This weakness is set to linger through the remainder of the year, with the Australian dollar unable to rally back past USD0.67. In terms of the risks, if the US FOMC does have to cut further than we currently anticipate, given the global nature of current uncertainties, downward pressure will remain on ‘risk-on’ currencies as commodity prices weaken and the US still retains a comfortable yield advantage. Hence, for the Australian dollar, the risks are arguably skewed downward.
Add NAB to the AUD bears, which now sees 65 cents before the year is out:
“Premised on the PBoC ‘allowing’ USD/CNY to trade up to the 7.35-7.40 area between now and year-end, albeit in a controlled manner such that market instability is contained and capital flight doesn’t necessitate large- scale FX intervention, AUD/USD is now seen falling to the 0.65 area in coming months.
“The read-through from an expected weaker CNY trend in the coming months to broader EMS, AUD and NZD is profound…almost exactly matches the size of the rise in USD/CNY (from 6.88 to 7.06) and fall in the broader EMCI global EM currency index – all by just over 2.5pc”.
Lower next year!