FYI | Nov 22 2008
By Andrew Nelson
The Reserve Bank has once again intervened in the foreign exchange market, the third time since late October, after the Aussie dollar fell below US61c for the first time in four weeks. While the central bank, by most estimates, will continue to make contributions to Treasury coffers despite the billions already spent in recent weeks, it will likely only delay the inevitable decline many are predicting.
The latest evidence of the pressure the Aussie is under comes from ANZ Bank, who has made a substantial downward revision to its forecasts due to the worsening outlook for global growth, weakening commodity prices and falling interest rates. Despite the fall from the high nineties to the low sixties in the course of a few months, ANZ now thinks there’s more decline to come, while the prospect of a rebound has been pushed out farther.
How low? 54c by the end of 2009, with the possibility of even more downside, say the economists at ANZ.
The prediction is underpinned by a few key assumptions. The first is that the Fed funds rate in the US will reach 0.75%, while the RBA cash rate will fall to 3.5%. ANZ is confident about both. The RBA commodity price index will also fall by 38% in USD terms on an annual basis by June 2009, also likely says ANZ, who notes that oil will hit US$40 per barrel in the not too distant future. A larger decline in commodity prices to below present forecasts would force an even further downgrade to its AUD forecast.
Such an eventuality would provide little forewarning. However, the team points out that significant selling pressure in the AUD would be a pretty good indication that commodity prices are about to move another step lower.
The main driver of the downgrade, the team notes, is its bearish outlook for global growth. ANZ notes that five of the G7’s largest economies are already showing contraction on a quarterly basis in the third quarter and all leading economic indicators are pointing to a global recession in the months ahead. ANZ’s outlook is “bleak”. It expects the G7 will expand by only 0.1% next year, while the team expects global growth across the board will halve from 4.8% per year last year to 2.4% next year.
The economists also see risk aversion as being likely to remain a significant drag on the AUD. Right now, ANZ estimates that the Aussie is actually trading at a US8c-10c discount to fair value due to its high trading volumes and its commodity currency status. ANZ sees these factors as causing investors to use the AUD as a proxy for emerging markets and other high-yield types of trades.
With risk appetites falling to almost nil in global markets, coupled with severe market volatility, the Aussie has been hit pretty hard and the bank thinks there is no way around the fact that this will continue in the months ahead. This, explain the economists at ANZ, is why their current spot rate forecasts are sitting at a marked discount to what they estimate to be fair value.
There may be a little bounce as we near year end given the significant discount to fair value, says ANZ, but caution is warranted as volumes are thin and volatility high and the end of each quarter over the past year has seen broad market sell-offs in response to tight liquidity conditions. If liquidity and lower volatility remain in the market in early 2009 and commodity prices continue their downward track, the Aussie could reach ANZ’s target even sooner than forecast.
