Why Australian dollar is lower than all bank forecasts

See the latest Australian dollar analysis here:

Nordea: US dollar boom ahead

All major forex prognosticators produce Australian dollar fair value models. They include the usual variables such as interest rate differentials, terms of trade levels. Westpac’s is typical:


All of these models work on the same basic themes and generally come out with roughly the same outcome, currently ranging from 80-85 cents.

So, why is the Australian dollar sitting comfortably below these prices? The first reason is that the models may not have adequately accounted for the RBA’s new quantitative easing regime. As Morgan Stanley argued yesterday, if such a regime were parsed into negative interest rates then the AUD is pretty fairly valued already:

The second reason is that the Australian dollar currently faces some atypical risks that are not easily captured in quantitative macro measures based upon previous cycles.

Chief amongst these risks is Australia’s ongoing trade war with China.  Although the impact on Australia has so far been small to the point of infinitesimal at the aggregate level, beneath that there is a dramatic narrowing of the trade relationship underway as everything except iron ore and LNG pulls back or outright collapses.

The risk profile of the relationship rises as it narrows, especially since, if it really got the shits, China could simply set a much lower purchases price for iron ore and there is not a whole lot that miners could do about it, which would instantly crash any and all fair value models for the AUD.

Thirdly, markets are rightly discounting the current iron ore surge as temporary. Despite all of the bluster about new commodity supercycles, it is no such thing in iron ore. There is plenty of supply, it’s coming back fast, and demand is going slow just as swiftly as stimulus and Chinese catch-up growth end.

Fourth, markets are also doing a reasonable job of discounting the unusual nature of the COVID cycle. This has two dimensions to it. With the US more fiscally driven than China versus the two previous cycles, the USD is much stronger than it was at similar stages of the cycle. This leadership has been augmented by worldbeating vaccine success, better than just about anywhere else.

In short, traditional Australian dollar fair value models are unable to capture the idiosyncrasies of this cycle and so keep overvaluing the Pacific peso.

David Llewellyn-Smith

Comments

  1. Doubt inflation will be temporary due to resolving supplier bottlenecks.

    To be able to raise interest rates, the current mega debts need to be inflated away.

    Therefore, wages are going to increase in nominal terms to match all the general price increases of everything.

    Fake cpi and fake inflation numbers and thus bank interest will be kept low and bank savings decimated. Interest rates are kept low by keeping bond yields low, done by the fed buying bonds with newly printed money.

    Only after prices and wages have doubled or more, will official interest rates be allowed to rise significantly, by tapering the bond buying, which allows bond yields to rise.

    To counteract the continual creation of mega debt, bond buying tapering may be wound back slowly over 5 years, plus more taxes. As debts are deflated, the rate of tapering and interest rate increases can increase.

    • Niall de Santos

      Long term banks might not like inflation:
      In an inflated future if you can pay back your old homeloan with one month’s salary it will destroy their mortgage books.

    • How I initially misread your comment.

      Only after prices and wages have doubled or more, will official interest rates will be allowed to rise significantly, by tapering the bond buying, which allows bond yields to rise.

  2. MathiasMEMBER

    I guess it pays to use your brain over a computer. Everyone wants the money they dont have to work for, I guess. Im guilty of that ha ha. Bad habbits, I suppose.

    > The second reason is that the Australian dollar currently faces some atypical risks that are not easily captured in quantitative macro measures based upon previous cycles.

    Yeah. Living in Australia kind of helps.

    Yellen:
    “Uncollected taxes amount to $7 trillion over a decade.”
    “Reallocation may result in some small increases in interest rates.”

    Its just an announcement but wow. If US intends on recouping back $7 trillion in unpaid taxes over 10 years, that’ll be a shakeup ha ha.

    “US President Joe Biden’s overall program will make big difference to inequality.”
    “There’s more to do around inequality than simply promoting education.”
    “Marginal tax rates are much less powerful in influencing growth than many thought.”
    “Little evidence of burst of investment after Trump’s tax cuts.”
    “Private investment will be critical to getting to net-zero emissions.”

    I like this guy. You think Biden would come be President of Australia? We might need that. This guys heaps better then ScoMo.

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