Dollar's slide tipped to end as rate cut expectations weaken
The dollar, which has shed more than 12 per cent of its value since mid April, has been trading around US92.5¢ in the past few days despite strong US economic data and Chinese credit crunch uncertainty - two factors that in recent weeks contributed to its demise.
The dollar started its steep decline in the second week of May after the US dollar started to find strength against other currencies, amid growing optimism about the strength of the US economy.
In its latest slump, the dollar shed nearly 4¢ to a 33-month low of US91.49¢ after the US Federal Reserve last Thursday signalled a possible end to its $US85-billion-a-month stimulus program. Since Monday it seems to have stabilised. It was trading at US92.63¢ about 3pm on Wednesday.
The lower dollar has also pulled down expectations of another interest rate cut by the Reserve Bank, with a weaker currency expected to help the economy transition away from mining-led growth. Westpac currency strategists revised their "fair value" forecasts for the dollar down from US95-96¢ to US91-92¢ on Wednesday and said the currency was now "trading around its equilibrium value for the first time since late 2011".
The analysts said they expected the fair value of the dollar to be about US90¢ throughout 2014, but trade with a "modest premium" to the fair value.
The revised fair value for the dollar was driven by weaker Chinese growth, lower commodity prices and movements in global yields and risk assets, the analysts said. They said the Australian dollar had reached a turning point, and would not return to parity with the greenback but resume its traditional role as a commodity currency.
Commonwealth Bank FX economist Peter Dragicevich said he believed the major adjustments to the Australian dollar were mostly over. He did not expect the currency to depreciate significantly over the next year.
"Over the last few years, the dollar traded above parity and had a disconnect with the more traditional drivers, such as commodity prices and interest rate differentials," Mr Dragicevich said.
"A lot of that was stemming from the increased capital flows into Australia. But they've since subsided and you are seeing the Aussie readjust back to its fundamental backdrop."
Commonwealth Bank forecasts the dollar to end the year at US96¢ and to trade about US95¢ by the middle of next year. The dollar is then forecast to fall to US91¢ by the end of 2014.
But Citi currency strategist Todd Elmer said he expected the currency to fall further and trade within the range of US85-90¢, rather than US90-95¢, in the next six months as China continues its economic slowdown.
"A structural rebalancing of the Chinese economy away from the quicker export-led growth of recent years towards a less commodity-intensive model of domestic-oriented growth is going to act as a lever for further Aussie weakness," Mr Elmer said.
After the dollar's sharp drop last week, expectations of at least one more 25-basis-point rate cut by the end of the year halved, with the markets pricing in a 68 per cent chance of one more easing move by the Reserve Bank, Credit Suisse data showed. Financial markets previously priced in at least one more rate cut this year.
Mr Dragicevich said while Commonwealth Bank had pencilled in an RBA cut in August, the decline in the dollar could remove the need for another near-term cut.
Barclays' chief economist Kieran Davies said a 9 per cent drop in the value of the Australian dollar was roughly equivalent to a 100-basis-point cut to the cash rate, and both factors could lift economic growth by close to 1 per cent. He expected the RBA to sit on the sidelines at its July meeting, but maintain its easing bias.
Federal Treasurer Wayne Swan also welcomed the lower dollar, saying in a speech on Wednesday that the moves "should help to provide support to some non-mining sectors if sustained, assisting the rebalancing occurring in our economy".
Mr Dragicevich said the key economic variable that could induce further rate cuts was local jobless figures.
Frequently Asked Questions about this Article…
The Australian dollar plunged more than 12% since mid-April and hit a 33-month low of about US91.49¢ after the US Federal Reserve signalled a possible end to its stimulus. By mid-week it had stabilised and was trading around US92.5¢–US92.63¢.
The fall was driven by a stronger US dollar as US economic data improved and the Fed signalled tapering, combined with worries about Chinese growth and a Chinese credit crunch. Weaker commodity prices and movements in global yields and risk assets also pushed the AUD down.
Westpac cut its "fair value" forecast to US91–92¢ and sees fair value near US90¢ through 2014. Commonwealth Bank expects the dollar to finish the year near US96¢, trade around US95¢ by mid next year and fall to about US91¢ by end‑2014, with its FX economist saying major adjustments are mostly over. Citi’s Todd Elmer expects further weakness, forecasting the AUD to trade in a US85–90¢ range over the next six months.
A weaker AUD has reduced expectations for another near‑term RBA rate cut because a lower currency helps stimulate the economy. After the sharp drop, market pricing for at least one more 25‑basis‑point cut this year was halved (Credit Suisse showed about a 68% chance), and some forecasters say the drop could remove the immediate need for another cut.
Analysts say a lower AUD should help Australia’s rebalancing away from mining‑led growth by making non‑mining sectors more competitive. Barclays’ chief economist estimated that a roughly 9% drop in the AUD is roughly equivalent to a 100‑basis‑point cash rate cut and could lift economic growth by close to 1%.
Yes — Citi warned the AUD could fall further as China continues to slow. The main downside risks named by analysts are a structural rebalancing and slowdown in China (less commodity‑intensive growth), ongoing weakness in commodity prices, and adverse moves in global yields and risk assets.
Investors should watch US Federal Reserve signals on stimulus/tapering, Chinese growth and credit conditions, commodity prices, movements in global yields and risk assets, RBA statements and meeting decisions, and Australian jobs data — local unemployment is highlighted as a key variable that could prompt further RBA rate moves.
According to the analysts quoted, the AUD is unlikely to return to parity. Westpac said the currency has hit a turning point and will resume its traditional role as a commodity currency rather than trading at parity with the US dollar.
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