When it comes to the Aussie dollar, markets mostly agree on one thing: it’s heading down.
Depending on any number of experts, the Australian dollar could drop as low as US$0.60. Or it could fall to US$0.50. It all depends. External and internal pressures may dictate its pace of decline. But not its direction.
What’s beyond any doubt is that markets retain a bearish outlook on the dollar. And in the long term, the Aussie dollar will certainly decline.
Yet as every investor will tell you, the end goal is only part of the whole picture. There’s the journey — the in-between — to think about. Forecasting that is easier said than done.
Opportunistic currency traders are on notice. The short term could provide bigger swings in the Australian dollar than you might think. At least that’s according to one leading fund manager.
David Solusky, of UBS Wealth Management, believes a dollar rally could very well be on the cards. He reckons the Aussie dollar might hit US$0.80 before it finds its long term floor.
Solusky remains a dollar pessimist. He reckons it will hit a low of US$0.65 over the next 12 months. But he’s right about one thing. Short term factors could conspire to drive the dollar higher. The most glaring of these reasons are global interest rate policies.
The idea behind this is logical enough. If global interest rates remain stuck at record lows, capital flight will take global capital elsewhere. Which is where Australia comes in.
We have relatively high interest rates compared to other developed nations. Although relative is a loose term… Aussie interest rates are still at a miserly 2%. But there’s always someone worse off than us.
US interest rates are set at 0.25%. Japan’s are at 0%. The European Central Bank has its official rate at 0.05%. All of which makes our 2% looks enviable by comparison.
And, unless global rate policy reverses, it could work against the Aussie dollar.
Global rates and the Aussie dollar
It wasn’t supposed to be this way.
Most economists expected interest rates to rise this year. The great global hope was that US rates would be first to go. Other central banks would follow suit, presumably. That was the plan, but it hasn’t transpired. The Federal Reserve got stage fright. Global volatility, and sketchy US data, was enough to scare them from lifting rates.
In the meantime, other central banks have gone the opposite way. The European and Japanese central banks launched new QE programs. The Bank of England cut rates to stave off deflation as well. These measures have left the Aussie dollar between a rock and hard place. Why? Because they drive capital to Australian shores. It acts like a release valve for the Aussie dollar, pushing it higher.
Australia’s higher interest rates raise the dollar’s appeal. Traders buy up Aussie dollar reserves, and its value rises in turn. This is what Solusky is getting at with his US$0.80 forecast.
He reckons traders are failing to price this scenario in. As a result, the rally could be sharper than many predict. That’s especially true if China’s economy rebounds. If China rallies, it would boost commodity currencies like the Aussie dollar. That’s a big if though.
Chinese growth for the year to September was 6.9%. It beat expectations, but dropped below the government’s target of 7%. Pinning hopes on a broader rebound is hasty at best. And there’s no guarantee it would be enough either.
It’s debatable whether China alone can boost the dollar to that degree. The dollar might require something more. Like, say, a new round of QE in the US. That isn’t beyond the realm of possibility, as unlikely as it may seem.
The Fed keeps telling us that rate hikes are a matter of when, not if. That may be so, but that’s merely the end point. In between there’s scope for more stimulus. Especially considering US rates can’t head much lower. More QE might sound absurd, but it’s likelier than betting on a Chinese recovery.
Should this happen, the dollar would rise sharply against the greenback.
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US stimulus and the Aussie dollar
In the event of more US stimulus, the Aussie dollar would climb higher. That’s a scenario the RBA is keen to avoid. For no other reason than the fact that a strong dollar hurts the economy.
Manufacturing, education, tourism, exports… it’d all take a hit. Tourism depends on foreign visitors. As does the top end of the education sector. The weaker the dollar, the cheaper it becomes to visit Australia. At the same time, an expensive dollar makes exports less competitive.
The other fear over this is that business spending would nosedive. That’s important as non-mining investment is seen as the key to avoiding a recession.
However, imports would receive a boost. Which might benefit consumer spending in the short term. But you won’t catch policymakers’ spruiking the merits of that. They want a weaker dollar. When it comes to currencies, it’s the blind leading the blind…
The way forward for the Aussie dollar
There’s two way things could develop from this point.
For one, US interest rates could rise. That’s what everyone is hoping for. Should that happen, it’d solve many of the world’s monetary problems. Central banks would stop easing for one. There’d be no need for it. The US dollar would rise, pushing other currencies lower. Other central banks would follow suit one suspects. Decade long low interest rate policy would reverse.
That would be the ‘best’ case scenario, anyway. But it’s also the least likely of the two.
The second way forward assumes that the Fed leaves its policy on hold. On top of which it forces through a fresh of QE stimulus. In the event, the race to the bottom would gather pace.
The RBA would have no choice but to play the same game. It would have to cut rates in response to other central banks. Otherwise the dollar could break above even US$0.80.
China too would join the bandwagon. It’s already cut rates five times in the past year. But rates would go lower, down from 4.6%. Yet China would just be another participant in this currency war. It wouldn’t solve any of the problems associated with weak global growth.
In the end, the global economy would plod along as it’s doing. Living month to month on the scraps of cheap credit. But at least the dollar would be weaker. Which is all that really matters in the end for central banks.
Without a real plan to fix the credit glut, kicking the can down the road is the easiest option.
Contributor, The Daily Reckoning
PS: The Reserve Bank kept interest rates steady at 2% last month. Yet as long as the US Fed maintains near-zero rates, the pressure will be on the RBA to cut again soon.
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