Prepare for an Aussie parity party

A sustained fall in the Australian dollar is on the way, and set to bring a degree of economic stimulus at a time of moderate growth.

The Australian dollar was smashed overnight, dropping almost 2 US cents to 1.0080 at the time of writing, having hit a low of 1.0045. Just yesterday, I was looking at the issues surrounding what looked to be the start of an Aussie dollar depreciation and while the strong jobs result yesterday gave the dollar it lift, it proved to be very short-lived.

The Australia dollar is on a clear trend down. At 1.0080, the Australian dollar is at its lowest since June 2012, which was also the last time it traded below parity with the US dollar.

Along with the interest rate cut earlier this week, the currency fall, if sustained, will give some support to exporters and help the local firms that are competing against importers. In other words, a sustained fall in the Australian dollar will give a degree of stimulus to the economy at a time when overall conditions are suggesting moderate economic growth.

For those reasons it is good news and long overdue.

The fall in the Aussie dollar overnight was triggered, it seems, by a strong rally in the US dollar which in turn was sparked by comments from Philadelphia Fed President Charles Plosser that the Federal Reserve has “limited” capacity for more stimulus. Any end to quantitative easing from the US would spell trouble for commodity prices and would undoubtedly spark a US dollar rise. We saw the early stages of that overnight. Also boosting the US dollar was another good reading for US jobless claims which suggest the economy remains on track to see yet lower unemployment ,with many now forecasting the Fed will meet its goal for 6.5 per cent some time in 2014.

Also hitting sentiment towards the Australian dollar was a report from Fitch rating agency that warned Australian banks their credit rating could be at risk unless they changed their funding mix, moving away from short-term deposits and more towards long-run wholesale funding.

A credit downgrade on the banking sector, for so long the darling of Australian markets and a target for global investors, would clearly be negative for the Australian dollar. Watch bank shares today to see whether any of the currency selling was preparing for an exit out of what look to be very expensive bank shares.

The Reserve Bank has been very reluctant to engage in currency intervention, even in mild form. In August last year, when the Aussie was around 1.0560, I argued that the Reserve Bank should start selling Australian dollars (An RBA recipe for Aussie dollar relief, August 7, 2012). And it is a pity it didn’t. The 4.5 per cent fall, to date, in the Aussie dollar would have locked in a nice profit for the bank, even allowing for the 2-3 per cent annual cost of carry.

Some Australian dollar selling may have also resulted in the currency being lower which would have helped, at the margin, support the export sector.

But it isn’t too late.

For the Reserve to intervene about now, when sentiment towards the Aussie dollar is starting to turn, would knock another cent or two off and get it to a level that is more consistent with the recent trends in commodity prices and the terms of trade.

It might also change the most fickle of market drivers – sentiment. Until now, global investors buying Australian dollars, bonds and stocks have had an almost free reign. Money for old rope type investment trends that feed on themselves can lead the market to overshoot. There is no doubt this happened to the Australian dollar as it defied the usual path of tracking commodity prices, which remain some 20 per cent below their peak.

But now, with some recent investors sitting on losses as the Australian dollar fall becomes meaningful – including against the yen, euro, British pound and of course the US dollar – a swing in sentiment is on the cards.

Stop losses, rather than booking profits could be the order of the day in the months ahead. This would only compound any further depreciation of course.

Policy uncertainty as election day (September 14) draws nearer may also weigh on investor attitudes towards Australia.

Across the Tasman, the Reserve Bank of New Zealand confirmed it had sold the overvalued New Zealand dollar, with Governor Graeme Wheeler saying directly “there has been some intervention”. The New Zealand dollar is currently around 2.5 per cent lower against the US dollar in the past 10 days and this despite a run of better local economic news.

Forecasting currencies is hazardous, but the recent influences on the Aussie dollar, its new fall and the change in sentiment suggests the 96 US cent target that Westpac’s Bill Evans has for 2014 will be hit much earlier than that and the fall could well be much sharper.