Aussie Dollar

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<p>EXPERT OBSERVER</p>
<p>This week we have received significant economic and policy updates from across the globe. From these, it is evident that Australia and New Zealand are both in a good position to rebound.</p>
<p>Beginning at home in Australia, this week’s August labour force update delivered a significant upside surprise, with 111k jobs created in the month and a 0.7ppt decline in the unemployment rate. This result leaves the unemployment rate at 6.8%, almost a full percentage point below our and the market’s expectation for August ahead of the release.</p>
<p>The gain for hours worked was materially lower than for employment, coming in at just 0.1%. However, this was due to a deep decline in hours worked in Victoria (-4.8%); the other states meanwhile experienced a 1.8% gain.</p>
<p>July and August’s employment gains mean the RBA’s 10% unemployment rate forecast for end-2020 is unlikely to be seen. To see such an outcome now, 400-500k jobs would have to be lost by December. This seems improbable, particularly with government support running into 2021. Westpac still anticipates however that the unemployment rate will rise to around 7.8% in late-2020/ early-2021 and that, come end-2021, it will still be elevated at around 7.5%.</p>
<p>The RBA is mindful of the economic damage of an extended period of high unemployment and so continues to make clear their willingness to support the real economy as long as necessary. Notably, in the September meeting minutes there was a clear focus on the state governments and the support they can offer the economy during a recession, particularly by borrowing to invest in infrastructure. Keeping borrowing rates low aids this opportunity.</p>
<p>Westpac Economics also made a significant revision to a key forecast this week. Previously we had anticipated a 10% decline in national house prices from April 2020’s peak to June 2021. Now however, we believe that decline is likely to be limited to about 5%, with 2.7% of that decline already seen. There are two key justifications for this view change, as highlighted by Chief Economist Bill Evans.</p>
<p>First is the benefit that has come to households in 2020 from lower interest rates, particularly as a result of the sharp drop in fixed rates to levels well below variable. Second are the upward revisions we have recently made to our growth and labour market views. Combined, these factors will support affordability, minimising further declines in 2020-21 and laying the foundation for a strong rebound in prices to new historic highs.</p>
<p>Turning to New Zealand, Q2 GDP came in in line with our NZ team’s expectations. GDP jolted 12.2% lower in the three months to June because of the lockdown measures implemented to stop COVID-19. All of the Q2 detail is available in their bulletin. But what needs to be emphasised here is that, while NZ’s lockdown was one of the strictest in the world, it was also highly successful, allowing the economy to rapidly restart. Our NZ team continue to anticipate a strong rebound over the second half of this year, leaving GDP within 5% of its pre-COVID trend. However, continued border closures will limit further gains in 2021.</p>
<p>On to the US and UK. From monetary authorities in both jurisdictions this week came clear guidance that policy will remain extraordinarily accommodative as far as the eye can see.</p>
<p>From the Bank of England, there was a commitment to assess the potential benefits of a move to negative interest rates. While the FOMC did not signal a clear intent to investigate the use of another policy instrument, their revised forecasts and qualitative guidance made clear that policy would remain at least as accommodative as it is currently for an extended period. Indeed, the median view of the Committee is that the federal funds rate will remain on hold till at least end-2023, at which time the unemployment rate would still be above its pre-COVID level and inflation only getting back to 2.0%yr. The statement only made a commitment to sustain purchases of US Treasury and mortgage-backed securities at their current monthly pace of around $80bn and $40bn respectively over coming months. However, the continued inclusion of the phrase “at least” with reference to the current pace makes clear the Committee’s concern over downside risks and implies that a partial then full tapering of asset purchases is also a long way off.</p>
<p>Combined with a broad-based recovery in the global economy, highly-accommodative FOMC policy supports our view that the Australian dollar will continue to rally to USD0.75 end-2020 and USD0.80 end-2021, a rate it is likely to sustain to mid-2022.</p>
<p><strong>ELLIOT CLARKE</strong><em><strong> </strong>is a senior economist at Westpac </em></p>
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Australia in a good position to rebound, especially the dollar: Elliot Clarke

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<p>GUEST OBSERVER</p>
<p>The US Federal Reserve lifted interest rates as expected.</p>
<p>In simple terms the economy is doing well, annual inflation is gradually returning to the 2 percent target level and emergency-level interest rate settings are not justified. Fed policymakers favour another two rate hikes this year.</p>
<p>But as always nothing is set in concrete. If there are big tax cuts then the Fed may need to be more aggressive with rate hikes. But if inflation remains tame, the Fed can take its time in lifting rates. It is basically that simple.</p>
<p>The federal funds midpoint target is now 0.875 percent, still well below the 1.5 percent cash rate in Australia. The Fed expects the fed funds rate to lift to 2.75-3.00 percent in the long-term, but that is a long way off.<span style="font-size: 12.16px;"> </span></p>
<p>Some commentators have been critical of the Fed. But things change – politics, oil prices, business and consumer sentiment. There are no guarantees, so you make decisions that are appropriate at the time.</p>
<p>If the Fed does indeed lift rates another two times in 2017, and indeed lifts rates three times as it currently projects in 2018, it will be in response to good economic circumstances. Firm growth in the US and China and improving growth in other parts of the world mean other central banks will look to lift rates.</p>
<p>It is too early to speculate on Australian interest rates. But the US rates move is yet another sign that Australian rates have bottomed. However the Reserve Bank will only lift rates if it believes inflation is headed for 2.5 per cent, meaning more “normal” rate settings are required.</p>
<p>It is important to highlight that the world has changed. Inflation is lower, globalisation and technology are keeping inflationary pressures low and interest rates are likely to peak at lower levels than in the past. Rate settings are still very accommodative across the globe, and that includes the US even after recent rate hikes.</p>
<p>The Aussie dollar rose over US1 cent in response to the Fed decision. Other currencies also rose – the main reason being that some investors thought the Fed would lift rates four times in total this year while the Fed is only flagging three hikes. The Aussie also lifted in line with higher commodity prices.<span style="font-size: 12.16px;"> </span></p>
<p>The higher Aussie dollar is positive for travellers and those looking to buy imported goods. But the higher Aussie is less positive for exporters and the tourism sector.</p>
<p>The health of the US economy, together with the data earlier this week showing good Chinese economic growth, are positives for the resources sector. The perception is that stronger business and consumer spending means stronger demand for raw materials and potentially higher prices. <span style="font-size: 12.16px;"> </span></p>
<div class="column"><a href="https://www.propertyobserver.com.au/images/2017/03/16/Screen%20Shot%202017-03-16%20at%209.41.55%20AM.png" target="_blank"><span style="font-size: 12.16px;">Click to enlarge</span></a></div>
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<p>Craig James is the chief economist at <a href="https://www.comsec.com.au/default.aspx"><span class="s2"><em>CommSec.</em></span></a></p>
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US central bank sets course for higher rates: Craig James

Financial stability, speculative mania and an eAUD? RBA's Philip Lowe

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<p>The <span>Reserve Bank assistant governor Christopher Kent says the </span>recent depreciation<span> in the Australian dollar has been "helpful" at a time where inflation remains weak and the economy is still using up spare capacity.</span></p>
<p>“While the exchange rate is still within the relatively narrow range of the past few years, the recent depreciation is helpful at the margin given that there remains spare capacity in the economy and inflation remains below target,” Reserve Bank of Australia Assistant Governor Christopher Kent said in a speech in Melbourne last Friday <span>hosted by FX provider XE</span>.</p>
<div class="hardwall" data-position="2">The address traced the fluctuating outlook in recent months as “modest revisions” to global economic growth and inflation combined with greater attention to downside risks from central banks and investors.</div>
<div class="hardwall" data-position="2"> </div>
<div class="hardwall" data-position="2"><span>"After a lengthy period of relative stability, global financial markets have been more volatile over the past few months.</span></div>
<div class="hardwall" data-position="2"><span> </span></div>
<div class="hardwall" data-position="2"><span>"The incoming data from around the end of 2018 was associated with a tightening in financial conditions: global equity prices declined; corporate credit spreads widened; issuance of corporate debt eased; and volatility picked up across most markets.</span></div>
<div class="hardwall" data-position="2"><span> </span></div>
<div class="hardwall" data-position="2"><span>"And in the space of only a couple of months, the market's expectations for monetary policies changed markedly and there was a notable downward shift in yield curves."</span></div>
<div class="hardwall" data-position="2"> </div>
<div class="hardwall" data-position="2">Kent noted local money markets switched their assessment of the next move in the cash rate to “more likely to be down than up.”</div>
<div class="hardwall" data-position="2"> </div>
<div class="hardwall" data-position="2">Earlier this month <span>Governor Philip Lowe tempered the bank's more optimistic language when the RBA kept the cash rate at a record low 1.5 per cent for a 30th month, but dropped its longstanding prediction that an improving economy meant the next move was likely to be upwards.</span>
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A$ adjustment assisting economy: RBA's Christopher Kent

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<p>EXPERT OBSERVER</p>
<p>The Australian dollar has held within a narrow range of USD0.704 to USD0.716 over the month.</p>
<p>Key commodity prices, particularly iron ore, have been stable over the month with spot at around US$90/t. General expectations have been for this price to adjust downwards. For example the government’s forecast for the iron ore price (fob) by March 2020 is US$55/t (Westpac expects US$74/t spot).</p>
<p>Supporting the iron ore price has been ongoing reports from Vale of likely decommissioning of supply following the collapse of the tailings dam in Brumadinho – general expectation is that Vale will decommission around 40t of production lowering overall annual production from 400Mt to 360Mt.</p>
<p>However markets are expecting even larger production cuts to eventuate. Another major producer, Rio Tinto, has also recently been impacted by a supply shock.</p>
<p>On the demand side, confidence is rising in response to China’s commitment to stabilising growth through lifting credit; easing restrictions on the shadow banking sector; supporting bond issues by local governments to finance new infrastructure investment; tax cuts; and some support to housing in selective regions.</p>
<p>This stability at high levels for key commodity prices is providing solid support to the Australian dollar – indeed the fair value of the AUD as measured by commodity prices, is currently holding well in excess of current spot.</p>
<p>On the other hand, interest rate differentials continue to weigh on the AUD. When on February 21, Westpac moved to forecast the RBA would cut the cash rate by 25bps in August and November this year, markets were not anticipating a cut until April next year.</p>
<p>That pricing has now moved forward to August/September with 75% of a second cut priced by mid next year. (pricing COB Wednesday).</p>
<p>However in a Q&amp;A follow-up to a speech on Wednesday to the American Chamber of Commerce in Australia, Deputy Governor Debelle is reported to have noted “Our expectation is that we will see decent growth in the economy…so we won’t have to get to that point [of cutting rates]”.</p>
<p>A test of that assertion will be when the RBA releases its revised growth; inflation and employment forecasts in the May Statement on Monetary Policy on 10 May. Currently, the RBA is forecasting GDP growth of 3% in 2019 and 2.75% in 2020. The lower growth rate in 2020 is largely explained by a reduced contribution from resource exports – particularly LNG.</p>
<p>Those forecasts were released for the February Statement on Monetary Policy when the RBA was forecasting growth of 2.75% for 2018. Subsequently, growth printed at 2.3% for 2018.</p>
<p><em>BILL EVANS is the Chief Economist at Westpac</em></p>
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Australian dollar holds as commodities remain stable: Bill Evans

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<p>EXPERT OBSERVER</p>
<p>While some have expressed surprise at the recent resilience in the value of the Australian dollar around the $US0.69-0.70 level despite weak Australian growth and Reserve Bank rate cuts, from a big picture sense it has already fallen a long way. It’s down 37% from a multi-decade high of $US1.10 in 2011 and it’s down 15% from a high in January last year of $US0.81. So, having met our long-held expectation for a fall to around or just below $US0.70 and given its recent resilience now is an appropriate time to take a look at its outlook.</p>
<p><strong>The $A is slightly undervalued long term</strong></p>
<p>The first thing to note is that from a very long-term perspective the Australian dollar is around or just below fair value. This contrasts to the situation back in 2011 when it was well above long-term fair value. The best guide to this is what is called purchasing power parity (PPP) according to which exchange rates should equilibrate the price of a basket of goods and services across countries – see the next chart.</p>
<p>If over time Australian inflation and costs rise relative to the US, then the value of the $A should fall to maintain its real purchasing power and competitiveness. And vice versa if Australian inflation falls relative to the US. Consistent with this the Australian dollar tends to move in line with relative price differentials – or its purchasing power parity implied level – over the long term. And right now, it’s around or just below fair value. But as can be seen in the last chart, it rarely spends much time at the purchasing power parity level.</p>
<p>Cyclical swings in the $A are largely driven by swings in the prices of Australia's key commodity exports and relative interest rates, such that a fall in Australian rates relative to US rates makes it more attractive to park money in the US and hence pushes the $A down. “Investor” sentiment and positioning also impacts – such that if the $A is over-loved with a lot of long positions then it becomes vulnerable to a fall and vice versa if it’s under-loved.</p>
<p><strong>The negatives for the $A…</strong></p>
<p>For some time, our view has been that the $A would fall into the high $US0.60s and this has happened. But notwithstanding this and that the $A has already fallen a long way from its 2011 high, it could still face a bit more downside over the next six to 12 months. The main reason is that Australian growth is weaker than US growth and spare capacity is much higher in Australia.</p>
<p>For example, labour market underutilisation is 13.7% in Australia versus just 7.1% in the US, growth in Australia is running at 1.8% year on year compared to 3.2% in the US and the drag on growth from the housing downturn is likely to keep growth relatively weak in Australia for the next year or so. So this all points to more downside for the Australian dollar.</p>
<p><strong>…and the positives</strong></p>
<p>Against this there are a bunch of forces acting to support the $A, and this has been evident in its relative resilience despite bad news in recent weeks. Firstly, global sentiment towards the Australian dollar has been negative for some time and this has been reflected in short or underweight positions in the $A being at extreme levels – see the next chart. In other words, many of those who want to sell the $A have already done so and this leaves it vulnerable to a rally if there is any good news.</p>
<p>Secondly, there has been good news with the iron ore price pushing above $US100 a tonne and this combined with solid growth in export volumes has pushed the trade balance into a record surplus which has shrunk the current account deficit as a share of GDP to its lowest since the 1970s. Of course, the iron ore price will likely fall back somewhat when Vale gets production back to normal after its dam disaster, but Chinese economic stimulus may help keep it and other commodity prices supported. The smaller current account surplus means Australia has become less dependent on foreign capital inflows.</p>
<p>Finally, in response to the threat to growth from President Trump’s trade wars, mixed economic data and weak inflation, investors have moved to price in rate cuts from the Fed over the next year. And this is negative for the $US generally after a multi-year bull market since 2008.</p>
<p><strong>So where to from here?</strong></p>
<p>Overall, we expect that the weaker growth outlook in Australia relative to the US and the likely continuing decline in the interest rate differential versus the US will dominate and push the $A still lower.But with the $A having already had a big fall, short $A positions running high, the current account deficit having shrunk and the US dollar looking toppy we see the $A falling to around $US0.65 on a six to 12 month horizon as opposed to crashing down to say the 2001 low of $US0.48.</p>
<p>Of course, if the global economy falls apart, causing a surge in unemployment in Australia as export demand and confidence collapses and another big leg down in house prices then all bets are off and the Aussie will fall a lot more…but that’s not our base case.</p>
<p><strong>What does it mean for investors?</strong></p>
<p>With the risks skewed towards more downside in the value of the $A, albeit less so than say a year ago, there are several implications for investors. First, there remains a case – albeit not as strong as it was when the Australia dollar was much higher – to maintain a decent exposure to offshore assets that are not hedged back to Australian dollars. A decline in the value of the $A will boost the value of an investment in offshore assets denominated in foreign currency one for one.</p>
<p>Meanwhile, the fall in Australian interest rates relative to global interest rates has reduced the incentive to hedge because when Australian rates are above global rates investors are “paid” to hedge. Second, if the global outlook turns sour due to say Trump’s trade wars, having an exposure to foreign currency provides protection for Australian investors as the $A usually falls in response to threats to global growth. As can be seen in the next chart there is a rough positive correlation between changes in global shares in their local currency terms and the $A.</p>
<p>Major falls in global shares associated with the emerging market/LTCM crisis in 1998, the tech wreck into 2001, the GFC, the Eurozone crises and the 2015-16 global growth scare saw sharp falls in the $A. So being short the $A and long foreign exchange provides good protection against threats to the global outlook.</p>
<p>Finally, continuing softness in the $A will be positive for Australian industry sectors that compete internationally like tourism, higher education, manufacturing, agriculture and mining and this will benefit shares exposed to these areas.</p>
<p><em>DR SHANE OLIVER is the Head of Investment Strategy and Chief Economist for AMP Capital </em></p>
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The $A still has more downside but much weakness has passed: Shane Oliver

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<p>EXPERT OBSERVER</p>
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<p><span>For a long time, we have been bearish on the Australian dollar,  </span>seeing a fall into the high $US0.60s and revising this to around $US0.65 in May. In early October it fell to a low of $US0.6671.</p>
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<p><span>While negatives remain significant for the $A there is good </span>reason to believe that we are close to the low or may have already seen it. This note looks at the main issues. </p>
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<p><strong>The negatives for the $A are well known</strong><span><br></span></p>
<p><span>The big negative for the Australian dollar is that growth is  </span>weaker in Australia and spare capacity is much higher than in the US.</p>
<p>For example, labour market underutilisation is 13.8% in Australia versus just 7% in the US, on the latest available data real growth in Australia is running at 1.4% year on year compared to 2% in the US and that translates to per capita GDP growth of -0.2% in Australia compared to 1.4% in the US.</p>
<p>And the drag on growth from the housing downturn, weak consumer spending and the drought is likely to keep growth relatively weak in Australia for the next six months or so.</p>
<p><a href="https://www.propertyobserver.com.au/images/2019/11/25/A%201.jpg" target="_blank">Click here</a> to enlarge: </p>
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<p><span>This will keep inflation lower in Australia than in the US. Ideally more fiscal stimulus is required, and the Government has brought forward infrastructure spending. But combined with extra drought assistance this only amounts to an extra 0.1% of GDP of fiscal stimulus over the next 18 months which is not enough to make a significant difference to the growth outlook. </span></p>
<p><span>So in the absence of more significant fiscal stimulus soon, the RBA is likely to cut the cash rate further to 0.25% and undertake some quantitative easing (ie using printed money to boost growth). By contrast the Fed is at or close to the low in US rates and is unlikely to return to quantitative easing. </span></p>
<p><span>This will continue to make it relatively less attractive to park money in Australia. </span></p>
<p><span>As can be seen in the next chart, periods of a low and falling interest rate differential between Australia and the US usually see a low and falling $A.</span></p>
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<p><span>So the higher probability of further monetary easing in Australia points to more downside for the Australian dollar. </span></p>
<p><span>Of course, a shift in the policy focus away from monetary easing and towards greater fiscal stimulus would be more positive for the Australian dollar but this looks unlikely in the short term with the Government more focussed on delivering a budget surplus.</span></p>
<p><strong>Five positives for the $A</strong></p>
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<p><span>However, </span><span>it’s </span><span>no longer an easy (in hindsight) one way bet for the $A. There are basically five positives. First, the $A has already had a big fall. To its recent low it</span><span>’</span><span>s fallen nearly 40% from a multi-decade high of $US1.11 in 2011 &amp; it</span><span>’</span><span>s had a fall of 18% from a high in January last year of $US0.81.</span></p>
<p><span>Second, this decline has taken it to just below fair value. This contrasts to the situation back in 2011 when it was well above long-term fair value. The best guide to this is what is called purchasing power parity according to which exchange rates should equilibrate the price of a basket of goods and services across countries. Consistent with this the $A tends to move in line with relative price differentials over the long term.</span></p>
<p><a href="https://www.propertyobserver.com.au/images/2019/11/25/A%203%20.jpg" target="_blank">Click here </a>to enlarge: </p>
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<p><span>And right now, </span><span>it’s </span><span>just below fair value. Of course, as can be seen in the last chart, the $A could fall sharply below fair value as it tends to swing from one extreme to another. But this depends on the cyclical outlook for global growth and commodity prices. Which brings us to the next positive.</span></p>
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<p><span>Third, the global economic and commodity price cycle is likely to turn up next year in response to global monetary easing, a bottoming in the global inventory and manufacturing cycle and a </span><span>4 </span><span>pause in President Trump’s trade wars </span><span>as he refocusses on winning the presidential election.</span></p>
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<p><span>Based on historical experience, this should work against the US dollar as the US economy is less exposed to cyclical sectors than the rest of the world (which tends to see capital flow out of the US when global growth picks up and into the US when it slows). A weaker US dollar would in turn be positive for commodity prices &amp; </span><span>the $A, which is a “risk on” currency given </span><span>its greater exposure to cyclical industries like raw materials.</span></p>
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<p><span>Fourth, this comes at a time when global sentiment towards the $A remains very negative as reflected in short or underweight positions in the $A being at extremes </span><span>– </span><span>see the next chart. In other words, many of those who want to sell the $A have already done so and this leaves it vulnerable to a rally if there is good news.</span></p>
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<p><span>Finally, the current account has returned to surplus in Australia. </span>The high iron ore price has helped, but so too have strong resource export volumes, services exports and a rising net equity position in Australia’s favour on the back of rising superannuation assets offshore. So the improved current account may be a permanent feature. This means less dependence on foreign capital inflows which is $A positive.</p>
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<p><strong>So where to from here?</strong></p>
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<p><span>The prospects for weaker growth and more monetary easing in Australia relative to the US suggests short-term downside pressure for the $A remains. But with the $A having already had a big fall to just below long term fair value, the global growth outlook likely to improve, short $A positions running high and the current account in surplus it</span><span>’</span><span>s likely that the $A may be close to, or may have already seen, its low. </span></p>
<p><span>Our base remains for it to fall to around $US0.65 as the RBA continues to ease but at the end of 2020 it</span><span>’</span><span>s likely to be stuck around $US0.65-70 (or </span><span>I’ll be honest </span><span>&amp; </span><span>admit I don’t have a strong view either way</span><span>!).</span></p>
<p><span>Of course, if the US/China trade war escalates badly again and the global economy falls apart, causing a surge in unemployment in Australia as export demand and confidence collapses and another big leg down in house prices the Aussie will fall a </span><span>lot more...but that’s </span><span>looking less likely.</span></p>
<p><strong>What does it mean for investors and the RBA?</strong></p>
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<p><span>With the risks skewed towards the $A bottoming soon the case to maintain a large exposure to offshore assets that are not hedged back to Australian dollars has weakened. </span></p>
<p><span>Of course, maintaining a position in foreign exchange for Australian-based investors against the $A provides some protection should things go wrong globally (say in relation to trade) or in Australia (say in relation to household debt).</span></p>
<p><span>For the RBA a shift in global forces towards being more supportive of the Australian dollar over the year ahead would com</span><span>plicate the RBA’s desire to boost Australian economic </span><span>growth. </span></p>
<p><span>Stronger demand for Australian exports would be positive, but upwards pressure on the $A would suggest that further monetary easing may be needed to help keep it down.</span></p>
<p><strong>Key points</strong></p>
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<p><span>In the absence of significant fiscal stimulus soon, further RBA monetary easing both in the form of rate cuts and quantitative easing point to more downside for the $A.</span></p>
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<p><span>However, there is good reason to believe we may be close to the low in the $A (or have already seen it): it has already had a large fall; it is just below fair value; the global economic cycle is likely to turn up next year; sentiment towards the $A is very negative; and the current account is in surplus.</span></p>
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<p><span>Our base case remains for the $A to fall to $US0.65 in the months ahead as the RBA eases further, but at the end of 2020 it</span><span>’</span><span>s likely to be stuck around $US0.65-70.</span></p>
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<p><span><em><strong>SHANE OLIVER</strong> is Head of Investment Strategy and Chief Economist at AMP Capital.</em></span></p>
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