Headwinds Forming For The Aussie Dollar

By David Bassanese | More Articles by David Bassanese

For a long while now, I’ve been predicting eventual weakness in the Australian dollar. Of course, given the Aussie battler’s stubborn resilience over the past year, it’s fair to say that call has been at best premature – and at worst, just plain wrong. But undaunted, I’m now sensing the $A is likely to face a serious test in coming months and may yet break to the downside, setting up a test of US70c by year-end.

Indeed, giving me some confidence in this view is the fact that the fundamental drivers of the $A remain don’t appear to have changed – and, as such, the $A persistent strength of late is easily explained. All that has happened is that these fundamental drivers have not moved (as yet) in the expected direction.

Indeed, last year we expected the United States Federal Reserve to continue raising interest rates – but after a market tantrum in January the Fed promptly backed away, not again raising rates until December. At the same time, China’s extra support for the steel sector and shift toward better quality coal and iron-ore imported steel inputs put a rocket under our key bulk commodity export prices.

These two factors conspired to keep the $A range bound in the mid-US70c range, even though the Reserve Bank of Australia did manage to cut local interest rates twice last year.

Fast forward to 2017 and there are clear shifts underway. For starters, coal and iron ore prices have started to correct. Our all-important iron ore prices may remain relatively well supported north of US$50 a tonne, but a sustain breach of $US100 is looking increasingly unlikely. China’s on-again off-again attitude toward support for its heavy industry – despite rising debt among unprofitable state-owned firms – could be headed into reverse again now that Chinese house price pressures are re-emerging.

And as is the way with markets, high prices are encouraging more supply – from both major miners in Australia and Brazil, but also from hard to kill high cost Chinese producers that were forced from the market when prices were lower.

The US Federal Reserve also appears more resolute this year in lifting rates. It signalled to a complacent market that it was keen to raise rates in March, and then duly delivered. It’s still promising at least two further rate rises this year, with the next instalment likely in June. And any hint that America’s red hot labour market is starting to generate accelerating wage growth could see the Fed get more aggressive. Adding fuel to the fire is US President Trump’s ongoing intention to cut taxes and boost infrastructure spending.

Meanwhile, excited talk that the RBA might hike local rates late this year to contain pressures in the Sydney and Melbourne property market has eased in recent weeks, as the banks themselves have acted to cool property demand by “out of cycle” increases in the their own mortgage rates.

APRA is also insisting bank reign in interest-only loans, which have made up a significant 40% of new lending in recent times. And in its post-meeting policy statement this week, the RBA painted a decidedly more measured outlook for local economic growth – jettisoning its early boast that growth could push 3% over 2017. Likely unnerving the RBA also is the revelation that the unemployment rate lurched up to 5.9% in February, countering the RBA’s view that is was set to gently decline over the coming year.

Could the RBA in fact cut interest rates again? If APRA’s and the banks’ own actions are successful in cooling the Sydney (and Melbourne) property markets, the unemployment rate breaks above 6%, and underlying inflation stubbornly refuses to push back toward 2%, the case for a late-2017 rate cut could easily fall into place.

At this stage, however, an RBA rate cut is not necessary to contemplate a breakdown in the $A – falling commodity prices and higher US interest rates should suffice.

Note investors seeking to exposure to a weak $A (strong $US) now have readily available options on the Australian Securities Exchange – via the USD and YANK ETFs.

About David Bassanese

David Bassanese is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares and former market columnist with The Australian Financial Review. He has previously worked in economist roles at the Federal Treasury, OECD and Macquarie Bank.

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