Westpac, NAB: Australian dollar to keep on falling

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!

Comments

  1. GunnamattaMEMBER

    I completely buy the AUD lower scenario, and think Macrobusiness (and particularly HnH) should be acknowledged as having been one of very few commentators on the Australian economy which has made the call from years out about the dynamics in play – and has clearly articulated the reasoning about why it will continue.

    Essentially we are in a situation where HnH made the call about where the AUD was going (strategically) – circa 2014 – was widely ridiculed/ignored, and we now have a situation where every mainstream bank, most of the business/economic media commentariat, and the RBA, has come to acknowledging the path that was called.

    The question for me from here is about how it gets lower, and how far it could, would, should go lower.

    The RBA is central to that path, and they have made a dogs breakfast of managing interest rates for quite some time, while using specious stats and palsied logic. As an organisation with responsibility for managing macro level demand in the Australian economy it would have to rank right up there with APRA as a failed institution. It has been primarily responsible for the housing bubble. As the financial system backstop it has obviously failed when it came to the banks. Presumably it sees the need to get the currency lower for demand support purposes. One question for me is the extent to which the demand support function runs head first into the financial system stability function – insofar as it has to make sure the path lower is a glide rather than a cliff walk. My baseline thought is that the RBA will almost certainly fail at this as it has its other key requirements.

    Part of the reason I think the AUD has remained pinned higher than it may otherwise have been (although this is now crumbling) is that global capital (traders, investors other central banks etc) know that it is a weak institution. My guess is that they have been banking on being able to slip into AUD and retain a relative safety there against a backdrop of sudden sharp events of the Trump China kind, and that even now there remains an interest rate differential – it is far more likely on any given day that either Trump or the Chinese will announce something than it is that the RBA or something in Australia generates any sort of event. Against that backdrop (and European and Japanese QE, and the grotesque economies therein, Brexit, Trump and China) I could see some sentiment to continue using the AUD as a sort of safety valve. The RBA (doing sweet FA) is more of a known known than other factors. So that sort of has me thinking in terms of possibly the AUD remaining higher than may otherwise have been anticipated, until such point as the global financial system incorporates Australia’s economic malaise into its thinking, or until such point as the RBA introduces a capacity to add an element of ‘surprise’ to the global financial system – exhibit A being the RBNZ double rate cut.

    I would have thought that once funds have any sense that the RBA and Australia has more ‘risk’ than it has in the past – and as capital markets start to see Australia as closing in on other moribund economies in terms of risk – then the path of the AUD is not just ‘down’ but potentially far more volatile.

    From there I wonder about the how far question, and longer term AUD history – The monthly and weekly look.

    The three standout jolts are the GFC – about a 30% correction from mid 90s (vis USD) to low 60s – the drop from above parity to low 90s (about 10%) and the drop from mid 90s to under 80 (another 10%) late in 2014. Since then it has followed through on the 2014 jolt to high 60s in 2015, which was followed by a rebound to circa 80 in early 2018, and a reasonably (if one sets aside the housing speculation and trashed banking regulation) pain free glide to high 60s since then.

    The last time the RBA pulled off anything similar to a long glide and subsequent gentle take off was the late 1990s and early 2000s. Back then Australia had the classic uptick in the tradables/exposed side of the economy, after it had glided lower to about 50s.

    The problem for Australia now is that much of that capacity to bring tradables (particularly manufacturing) into play for an uptick has been coughed up. Through a combination of monetary policy sacrificing of manufacturing, free trade agreements prioritising low value adding agriculture and mining over high value adding services and manufacturing, policy settings promoting (almost blackbirding) housing speculation over economically productive investment, and gross national stupidity in the management of Australian energy. That has been replaced in a demand sense by either inward facing services or retail (and generally very low skilled, low paying), or by shunting government jobs about, but most noticeably by the population ponzi – which Macrobusiness has again distinguished itself by being about the most honest, data backed and open commentator upon (this time mainly Leith taking the lead – and again with a lot of overt accusations of racism, widespread ridicule, or general dismissal from Australian mainstream media, the political mainstream, and the ‘identity’ interests).

    From there I come to thinking that the population ponzi is essentially an investment in low skilled, low paying, feebly competitive, inward facing economic dynamics which will only become really noticeable when the policymakers start thinking they are needing an export competitive, value adding, high paying sector of the economy to craft an economic upturn.

    To bring us back to the AUD it is precisely that value adding, export competing, higher paying sector that the RBA is hoping/praying/begging for about now. The recent rate cut and those to come are essentially a monetary policy attempt to find that. I find myself wondering if it will only be at the point where policymakers think they have found it it and begin to rely upon it (sort of like someone placing a foot on a step, or a ladder rung) that the real ‘Oh no!’ sets in.

    I think Australia can steady the descent with a population ponzi, but it cant gain a lift from one (particularly with its other economic settings), and that as need for that lift becomes more apparent (like when Australian returns to current account deficit on a sustained basis) then into the 50s (at least) or maybe even 40s is still quite plausible.

    Time to get my kid to soccer. But they are my initial AUD related thoughts this bitterly cold day in Geetroit.