AUD: Softening for the moment - Westpac

Elliot Clarke, Senior Economist at Westpac, explains that the Australian dollar, having traded in the range of US75¢ to 77¢ in the opening four months of 2017 broke to the downside in May, slipping to 73.5¢, to be around 74¢ currently.

Key Quotes

“The past two months have seen a number of forces weigh on the currency, most notably commodity prices and US monetary policy. Both developments are in line with our long–held expectations.”

“While we see further weakness in Australia’s key commodities through 2017, it is the second leg down come 2018 that we anticipate will have the largest impact on the Australian dollar. From our current year–end target of USD0.73, which is broadly in line with the current spot price, we expect the Australian dollar to depreciate to USD0.65 by end–2018. With respect to commodities, this will come as a result of a circa 30% decline in the price of iron ore through 2018 and a 40% fall for coking coal. Oil (Brent) is seen down a more modest 18%.”

“The other key factor behind our profile for the Australian dollar remains global monetary policy, in particular the course being chartered by the US Federal Reserve.”

“In the US, there remains a material disparity between sentiment/employment and spending. While it is certainly the case that GDP growth in the March quarter (which was a very poor at 0.7% annualised) was affected by weather and an inventory draw, the bigger question remains why average growth in domestic demand can seemingly not accelerate away from circa 2%yr – a pace it has now sustained over five years, and one that is little more than half that seen in the decade preceding the GFC (to end–2005).”

“When thinking about the Australian dollar outlook, it is also worth assessing current market expectations. As it stands, market pricing is only factoring in three rate hikes by the FOMC to late–2018 compared to our four and the FOMC’s five. Further, it is also difficult to assess whether the potential consequences of balance sheet normalisation and higher term interests have been factored into the market’s current valuation of the US dollar. Hence, while the Australian dollar has comfortably remained in the mid–70’s in recent months (and will likely do so for the remainder of the year), there is every reason to suspect that, as we move through 2018, sentiment will shift and see the currency trend lower to our end–2018 target of USD0.65.”

“As a final point, it is also worth highlighting that the recent run of Australian domestic data has, on the whole, been a negative for the Australian dollar. Albeit weather affected, available partial data for retail sales points to a broadly flat outcome for the March quarter. Further, expectations regarding family finances and spending intentions as well as considerable slack in the labour market and the looming downturn in residential construction indicate that risks regarding the consumer in 2017 and 2018 are to the downside.”

“As was apparent in the Federal Budget and recent communications from the RBA, authorities remain constructive on the outlook. Yet to our mind, there is good cause to highlight the downside risks, and bear particularly close attention to developments around the consumer. An RBA on hold throughout the forecast period will do little to offset stronger momentum and sentiment offshore.”