Betting against a bottomed dollar

Despite rising a little to 91.25 US cents this morning, the Australian dollar touched a fresh 3-year low of 90.40 US cents yesterday. When the US Federal Reserve starts to tighten monetary policy, probably in the next 10 to 12 weeks, there is a genuine risk that a supercharged US dollar could drag the local currency lower.

This seems to be the main theme behind the rush from market economists and strategists to abandon their “rebound to parity” forecasts of a few weeks ago and move to 85, 80 or even 75 US cents as a central case forecast.

There is another part to the story of a weaker Australian dollar and that is soft commodity prices brought on by a looming glut of production (Heavy going for lead-footed commodities, Mar 12). Despite a hint of uncertainty about the growth outlook in China, there seems no doubt that global GDP growth will be stronger in 2014 than in 2013, driven by the US but also a bottoming and perhaps a gentle lift in the eurozone.

Yet commodity prices are generally flat to lower and Australia’s terms of trade are likely to weaken further over the next year or so as the global production boom for mining unfolds.

Whatever the direct causes of the Australian dollar depreciation, it is extremely favourable news for the Australian economy. To have the trade exposed parts of the economy functioning with a lower value currency will see the export sector get a cash flow free kick as it will simply get more money in Australian dollar terms for a given volume of exports.

As a result of a further surge in exports, it seems likely that Australia will run large and increasing international trade surpluses on the balance of goods and services over the next few years. It is also likely that exports will be making a decent contribution to GDP growth which should see bottom line growth rise above 3 per cent.

Another significant positive for the Australian economy will show up for firms that have been lamenting the extreme difficulty they have had competing with cheap imports.

All of a sudden, it is less cheap for Australians to travel overseas, which means that those who chose to holiday in Queensland or Tasmania rather than going to Bali or New Zealand will be adding to the domestic economy. The local economy will be better off. At the same time, if a foreign tourist is lured back to visiting Australia rather than somewhere else because it is now cheaper in US dollar or euro or yuan terms to visit, the benefit is obvious too for hotels, shops and tourism operators. Tourism operators are already rejoicing.

It is the same issue for education, manufacturing and even the retail sector. The price in Australian dollar terms of that online item priced in US dollar terms is now almost 20 per cent higher than just a few months ago. This will no doubt drive some consumers back to local retailers.

Manufacturers who have kept their heads above water for the two years the Australian dollar was above parity must now be laughing and building their profits as it dips towards 90 cents. The universities are likely to see a lift in enrolments from foreign students given the fees in non-Australian dollar terms are cheaper and the cost of living in Australia has fallen.

And so the story goes on.

There will likely be a small lift in inflation as a result of the weaker Australian dollar. But as we saw when the currency appreciated so dramatically, the impact on inflation is relatively minor, a point I made last week when looking at the effects of the depreciation in inflation (Dispelling dollar gloom on the inflation horizon, July 3). 

For the Reserve Bank, there has been a collective sigh of relief that some of the distortions and imbalances that were building within the economy due to the overvalued currency are starting to ebb. It is also aware that the boost to competitiveness will take some time to work its way into growth, inflation and jobs. 

Which means the Reserve is still likely to cut interest rates again, probably in August. The two main pieces of local information that will sway the decision are the jobs data this Thursday, where a rise in the unemployment rate is likely, and the inflation data on July 24, which is likely to be low enough to allow for one more rate cut.

This in itself is likely to see the dollar fall a little more and it remains the case that we are more likely to see 85 US cents in the not too distant future.