The $A has been on something of a rollercoaster ride over the past few weeks.
Two weeks or so ago it fell below US$0.68 amid talk of interest rate cuts by the Reserve Bank of Australia (RBA) after the release of weak Australian economic data. The $A volatility was made worse by a ‘flash crash’ in some currency markets which helped push it down towards those lows.
But then it rallied, pushing up to the US$0.72 level on increasing talk that the US Federal Reserve would pause its increases in US interest rates.
So, what is happening?
Despite the recent rally, we still see the broad trend in the $A as down.
Firstly, a lot of this market volatility, which we have particularly seen in share markets, will continue for some time and relates to broader volatility in global financial markets.
But the main reason for the ongoing downward trend in the $A is the likelihood that our interest rates are headed down, while rates in the US are likely to remain stable or rise slightly.
In America, the Fed will take a much more cautious approach to interest rates this year in the wake of financial market volatility and signs of slowing global and US growth. They are probably on pause for the first six months of 2019, and it’s likely they won’t raise rates that much for the remainder of the year if at all.
Reasons to cut
Domestically we see the RBA cutting interest rates in response to weak, sub-par economic growth in Australia, as the housing cycle turns down, and fears that will weigh on inflation.
Economic data in Australia over the last three weeks has been soft, with continued weak car sales, waning momentum in job ads and vacancies, falling business conditions in December, soft consumer confidence and ongoing weakness in the housing market, including a sharp fall in residential building approvals.
Retail sales growth was okay in November but disappointing given the new-found excitement over Black Friday and Cyber Monday sales.
We believe the RBA will cut the cash rate from 1.5 per cent to 1 per cent this year. That, in turn, means the interest rate differential between Australia and the US will continue to push further into negative territory. (Official interest rates in the US are currently 2.25 per cent to 2.5 per cent.) Money seeking higher yields in the US will flow out of Australia, ultimately pushing the $A down.
So even though we have seen a bit of a bounce lately, the down trend likely remains. Between now and the end of the year we expect to see the $A in the $US0.60s. For investors that means there is a case to be short the $A – i.e. positioning for a fall. Being short the $A is also a good hedge against things going wrong with the global economy.
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