March 2015

How low can the Australian dollar go?
The Australian and US dollar cross rate has fallen 13.8 percent over the past year, tempting analysts from all backgrounds to take on the endeavour of surmising its ultimate fate. An influx of speculation on central bank policies, trade outlook, bond prices, commodity prices and housing prices have been force fed to those looking for insights. Virtually all aspects of the economics textbook have been passed on as “key indicators” on the Australian dollar’s movement.

So, who do we believe?

Under pressure from the torrent of expansionary policies across global economies and various sluggish economic indicators, the Reserve Bank of Australia (RBA) reduced the cash rate to 2.25 percent in February 2015. Following the news, economists at two of Australia’s largest banks pinned the average cross rate to just below A$0.75. Although one was more pessimistic than the other, both recognised the rate cut as necessary and one expects another cut towards the end of the year.

Economists consider the bulk of the Australian dollar’s decline against the US dollar to have already occurred and the now lowered rate will start to drive key export growth, causing the currency pair to enter a period of stabilisation.

Australian businesses agree with the economists. In East & Partners (E&P) research conducted in February 2015 based on forecasts made by CFOs and Treasurers in Australian trade businesses, the AUD/USD average cross rate consensus reached A$0.76 for the remainder of 2015. Over 80 percent of trade businesses are confident that the Australian dollar’s short term, drastic depreciation due to trade deficit will be self-corrective as service exports become more attractive to foreign buyers.

At the opposite end of the spectrum, fixed income analysts expect the pair to trade at as low as A$0.50, eliminating conservatism from its core. Basing their calculations on the differentials between Australia and the US’s five-year bond yields, fixed income analysts deduced that if the only other time the differential settled at 50 basis points was when the pair was trading below 50 cents, the cross rate will fall towards the same level again in the medium term.
Incredible, yes. Improbable, no.

Investors who are currently accessing low cost funds in the US and investing in Australia’s higher yielding assets are already pulling back. Following the US Federal Reserve’s rate hike and the RBA’s recent cash rate ease, the AUD/USD cross rate has already dropped 1.78 percent since early February. If the economists are correct and the two central banks continue to extend their respective monetary policies, the cross rate could indeed fall below the 50 cent mark.

Fund managers who focus on Australia’s resource exports on the other hand expect the cross rate to reach A$0.70 over the next few months, amid the recent slump in resource and energy commodities. This is a near ten percent depreciation on top of the 4.6 percent the pair’s cross rate has already experienced since the beginning of the year.

The decline is mostly triggered by flat income due to depressed Liquefied Natural Gas (LNG) and iron ore prices, which by extension, are dismantling Australia’s current account. This coupled with the current downbeat consumer sentiment, has exacerbated the expectation which many see as the final demise of the resource boom.

The relationship between export demand and the level of AUD/USD cross rate has been further explored in other, separate research conducted by E&P. Between August and November 2014, trade businesses with turnovers A$500 million or more expected their exports to grow by 9.8 percent, during which the AUD/USD cross rate fell by approximately 9.1 percent. For the quarter after, these businesses expected their exports to grow by 10.1 percent, during which the AUD/USD cross rate fell by close to 10.9 percent. If this relationship holds, the latest forecast of 10.9 percent export growth will see the AUD/USD fall to A$0.69 by June 2015, synonymous to predictions made by the fund managers.

Faced with such multifaceted views and opinions, we should be listening to those Australian enterprises whose business success or otherwise is glued to their AUD/USD predictions and the strategies they deploy and invest in.

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