Call us on 1300 794 893

The Experts

How high can the Aussie dollar rise?

David Bassanese
Wednesday, April 20, 2016

Bookmark and Share

By David Bassanese 

The Australian dollar has zoomed higher in recent weeks, which is naturally leading to some fears about its impact on the economy.  That said, one thing I have learnt studying our economy for the past two decades is that the little Aussie battler – god bless it !- does not usually get too far out of line with fundamentals for too long.  

Our freely floating dollar may bob up and down in the often torrid sea of global capital flows, but the currents usually flow in the right direction.  

Accordingly, if the $A stays above US70c in coming months, it will likely be for reasonably good reasons.  And if it drops below US70c – as I still expect – it will be for good reasons also. 

Only as recently as mid-January, the $A had sunk to a low of US68c.  I, of course, was crowing loudly, as I had predicted almost a year earlier that it would reach this hallowed level by end-2015. I was two weeks premature.  In January, all was falling into place: commodity prices were down, the United States Federal Reserve had just started to raise interest rates, and our own Reserve Bank still had a rate cut on the table.  

Alas, as it often the way with markets, what had become a consensus view was soon blown out of the water.  

What changed? For starters, the United States Federal Reserve quickly got cold feet due to US dollar strength and started backing away from further interest rate hikes anytime soon.  That sunk the US dollar, which in turn help buoy global commodity prices and the Australian dollar. 

If that were all that had happened, however, we’d have to conclude the $A was rising for the wrong reasons – a weaker global outlook, and one in which Australia’s relatively high interest rates were attractive to nervous and yield hungry international investors. 

But that’s not all that happened.  Through timely fiscal and monetary stimulus, China has again frustrated the doomsayers by keeping its economy ticking over and even leading to some rebound in property prices and housing construction.  This lift in the Chinese outlook for steel, still high Chinese steel exports, and cutbacks in iron ore supply by high-cost Chinese suppliers all conspired to helped support Chinese iron ore imports and prices.  Spot iron ore prices are up 40% this year to be just shy of US$60/tonne. 


Source: Metal Bulletin

Then there’s the Australian economy.  December quarter economic growth surprised on the high side, thanks in large part to stronger than anticipated growth in consumer spending.  The unemployment rate has not only stopped rising but appears to be trending down again. And – as I noted last week – survey measures of business conditions have improved.  Any lingering expectations of a near-term rate cut – even with the higher Australian dollar – have been crushed. 

So there are some fundamental drivers behind the $A’s recent rise.  That’s partly why the RBA has only engaged in gentle jawboning of the $A so far. 

If the $A stay high, it will likely reflect continued firm commodity prices and upbeat local economic conditions.  Less justifiable, of course, will be $A stays high merely because the Fed stubbornly refuses to raise interest rates – conditions under which the RBA’s ‘jawboning” might intensify, even if it were to prove futile. 

Indeed, some market pundits suggest the $A could reach US80c before long – and given the run of recent events it would be hard to argue otherwise. After all, the Fed looks unlikely to raise rates before June at the earliest, and China and the Australian economy are humming along reasonably well.

That said, I still see more $A downside than upside over the coming year for several reasons.   For starters, the underlying momentum in the US economy still seems strong, and the Fed will eventually need to bow to the inevitable and lift rates. 

And even if China’s economy keeps ticking over, the supply overhang in many commodity markets still remains. Indeed, high prices seem to be sowing the seeds for their own downfall by encouraging high cost producers back into the market.

Closer to home, I’m still nervously scanning the horizon waiting for the now established downtrend in local home building approvals to filter through into a reduced pipeline of labour-intensive housing activity.  And in a classic catch-22, I also note that a good chunk of the improvement business conditions since mid-2015 – evidence of which has lately helped support the $A – was in fact a reflection of earlier $A weakness.  Business sentiment could easily sour again if the $A stays high. 

All up, the current fundamentals supporting the $A seem unlikely to last.  Should the $A move much higher – and certainly if it gets near US80c – it might be the greatest “short trade” since America’s sub-prime mortgage crisis.

Published: Wednesday, April 20, 2016

New on Switzer

blog comments powered by Disqus
Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300