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Headwinds Building For The A$

To my mind, the $A appears on the cusp of its next major move lower. If you were not already a buyer of US dollars (such as through a $US ETF), the $A recent rally would have been a great time to get onboard.

But it’s still not too late. My long-held call has been that the $A would reach US68c by year-end, before falling to US65c by mid-2016. But it would not surprise me if the $A fell more quickly than this – in fact, when it moves, the $A tends to move quickly to a new level at which is rests for a while.

The $A has recently had a little move higher. From a low of US69.46c on 8 September, the $A then rallied to US73.44c on 13 October. The key reason the $A rallied is because the United States Federal Reserve surprised markets by not only not raising interest rates in early September, but expressing such concern over the global economy that suggested it might not raise rates until mid-2016.

But although the $A has since slumped back to around US70.85c, it not too late to get on board with $US dollar exposure.


Here’s why.

For starters, the United States Federal Reserve appears again to be steeling itself to finally raise interest rates at the December policy meeting. Although it baulked at raising rates this week, it did tweak the wording of its latest policy statement to again downplay the risks to the global economy. And the Statement also specifically referred to the possibility of a rate rise at its next (December) policy meeting.

I’d note, moreover, that far from pleading with the Fed not to raise interest rates, several emerging market economies (which are at risk of destabilising capital outflows as US interest rates rise), have actually started to argue the Fed should simply get on with it to end the lingering uncertainty in global markets.

Barring a sudden turn for the worse in US employment – which seems unlikely – I’d consider a December Fed rate hike a virtual done deal.

But the Fed is not the only negative factor for the beleaguered Aussie dollar. On the home front, expectations for a further interest rates cut have lifted.

Indeed, the RBA knows that the across the board mortgage interest rate increases by the major banks will add to downside risk to the property market and consumer sentiment that will need to be watched carefully. At the same time, this past week’s September quarter consumer price inflation report was much better than expected, with underlying inflation only rising by 0.3% (market 0.5%) and by 2.2% in annual terms.

Some economists suggest all this should be enough for the RBA to cut rates next Tuesday, but I’m still not so sure – as a range of business sentiment indicators are still holding up well, as is the labour market. Although I still see the RBA eventually cutting rates to 1.5% by mid-2016, I suspect it will want to save its ammunition for what it considers possible (and I consider probable) tougher times ahead.

Last but not least is the commodity price outlook, which continues to deteriorate. Indeed, sport iron ore prices appear at increasing risk of breaking below the recent lows in the mid $US40/tonne range.

Two forces could send iron ore prices lower. First would be an overdue rationalisation among the myriad of Chinese steel producers, who are continuing to buy ore and make steel even at a loss. Of course, one way they’ve justified keeping up production in the face of weak local Chinese demand is to flood exports markets – but that is just sending global steel prices (and their losses) further south.

It’s been reported that major Chinese steel producers have lost 28.12 billion yuan ($US 4.42 billion) in the first three quarters of 2015. Slowly but surely, some of China’s largest steel makers are now starting to close down unprofitable plants. In turn, that will impact on iron ore demand.

Meanwhile iron ore supply continues to rise, with Gina Rinehart’s Roy Hill mine slated to start adding to the global glut within coming months. China demand continues to wane while a wave of new supply is coming onto market – and our high cost producers are not cutting as quickly as they should.

All up, there’s heady mix of negative factors that seem likely to conspire over the next few months (if not weeks) to send the $A back on its merry way south.

View More Articles By David Bassanese

David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.



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