Come Hell or High-water, the Aussie Dollar is Going Down

Australian One Dollar Coins over Black
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The Aussie dollar is a resilient currency. Just when you think the chips are stacked against it, it keeps its head above water. So it proved again today as the Aussie rebounded to a 10 day high, despite the continuing commodity price rout. At 3:00pm AEST on Thursday, the dollar was up almost 1%, buying US$0.71.

The Aussie dollar had lost some of its value overnight. News of sliding oil prices played a significant part in that. West Texas Intermediate crude fell below the US$40 a barrel mark. US oil inventories haven’t been as plentiful in over 85 years.

All in all, commodity markets forced through a topsy-turvy 24 hours for the Aussie dollar. From a high of US$0.71 on Wednesday, the dollar slid to US$0.70 overnight. As of Thursday afternoon, it’s back above the US$0.71 mark.

With commodities sliding, why is the Aussie not buckling under the pressure?

Part of its recovery stemmed from the release of the FOMC’s (Fed) October minutes.

The minutes cast some doubt on the future of the Fed’s rate policy. Not a lot of doubt, as everyone remains convinced that US rates are heading up in December. But the minutes were much less hawkish than the Fed itself let on over the past few weeks. Commonwealth Bank’s currency strategist Elias Haddad summed it up well:

That kind of dampened a little bit the US interest rate expectations at the long end’.

In other words, the message from the Fed was more lukewarm than anticipated. The minutes implied a rate tightening is coming. But that it could be a drawn out affair. It’ll be a slow process, presumably for fear of causing too much volatility in the global economy.

Despite lowering expectations, the likelihood of a rate cut in December remains priced in at 68%. Should a rate hike take place in December, the US dollar would strengthen overnight. Were this to happen, it’d put pressure on all other major currencies. Especially commodity currencies like the Aussie dollar.

But if the minutes serve as any guide, the effects on the dollar might not be felt strongly. Sure, commodity currencies would take some hit. But a small rise, even say 0.25%, in US interest rates won’t move the needle too much.

It needs several bumps to have a lasting effect on the Aussie dollar. Otherwise the Aussie could end up bouncing back as quickly as it falls. Without a clear path for US interest rates, the effects on commodity currencies could be marginal.

Nonetheless, it’s clear there’s little upside for the Aussie dollar anymore. The only question is how far and fast it will fall. The quicker the Fed starts hiking, the sooner this process can start. Right now, this uncertainty is the only thing keeping the Aussie dollar from falling into the mid 60s. Were it not for this, the commodity rout may have been enough in bringing the Aussie to that level on its own.

The RBA’s role in the Aussie dollar’s decline

The Fed rate decision is the most important downward factor facing the Aussie dollar. But it’s not the only cog at play. The other elephant in the room is the Reserve Bank of Australia’s own rate policy.

Not a month ago markets were convinced the RBA wouldn’t dream of lowering rates again. Look how quickly that narrative changed. Not only does a rate cut look likely now, but it’s probable. RBA governor Glenn Stevens admitted as much last month.

Aside from interest rates, there’s always the ongoing issue of commodity prices. Iron ore was up 1.37% today. But that rebound came after falls of 4.5% yesterday. At present it’s trading at US$46.35 a tonne. Any sustainable recovery looks to be beyond the metal.

Copper fared even worse. The price of copper fell 1.35% overnight. Since the start of the month the metal is down 8.6%.

Aussie gold is also down almost $50 in the past week. It’s trading at $1,501 an ounce. That’s down $100 from this time last month.

The Fed, the RBA and commodity prices are the holy trinity of downward factors weighing on the Aussie dollar. As long as these risks remain in the market, the Aussie has little upside to it. While the Aussie dollar remains resilient for now, it won’t be long before these factors catch up with it. At that point, a floor of US$0.60 won’t be unrealistic.

The only real question then is when and how fast interest rates start rising in the US. And whether the RBA follows up by reducing rates on our end.

Some might argue that there’s no basis for a rate hike in the US. It’s debatable whether or not the US economy is ready for credit tightening. The economy isn’t improving that much. Job growth undershot targets last month. And consumer demand is slowing. Yet markets are wedded to the idea that a rate rise is imminent. Why? Because the Fed tells them so. There’s no other plausible explanation for why this belief is so widely held.

Markets are taking the Fed at their word, which is a dangerous game. Remember, this is the same Fed that said the exact same thing back in September. And in October too.

If it proves to be another damp squib in December, the resilient Aussie dollar will carry on defiantly. In the long term though, there’s only one outcome for the dollar. If commodities don’t bring it down, the Fed will make good on their word one day and hike rates.

The only problem for currency traders is predicting when that day is coming. The release of the October minutes didn’t make things any easier on them.

Mat Spasic,

Contributor, The Daily Reckoning

PS: According to The Daily Reckoning’s Phillip J. Anderson, interest rates could remain low for a long time to come.

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That’s why Phil wants to show you the best way to invest in this low interest rate environment. He’s prepared a four pronged strategy that’ll boost your wealth. You’ll learn where to park your cash over the coming decades to profit immeasurably. To download the report, click here.

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