Currencies | Jul 25 2011
– CBA sees many factors in favour of a stronger AUD
– Global growth still strong, should support commodity prices
– Aussie currency strongly correlated to Asia
– US dollar remains under pressure
– New post float highs expected against greenback
By Chris Shaw
While events in Europe have driven some risk aversion back into financial markets, Commonwealth Bank notes the Australian dollar has proven relatively resilient. This supports the bank's view there are several reasons the Aussie dollar is likely to record fresh post float highs against the US dollar.
One reason is, despite European sovereign issues causing concern, global growth has remained strong and not been revised down materially. This reflects Asia and Latin America being the main drivers of growth, rather than Europe.
As evidence, CBA chief currency strategist and head of international economics, Richard Grace, notes the International Monetary Fund forecast for global growth in 2011 has been re-affirmed at 4.3%.
Second, Grace notes commodity prices remain firm, which suggests any easing in risk aversion should generate a fresh lift in commodity prices and therefore the Australian dollar.
Grace also points out Asian exchange rates are pushing fresh cyclical highs, which is a positive for the Aussie dollar. This is due to strong correlation thanks to 75% of Australian merchandise exports going to the Asian region.
Another supportive factor for the Australian currency is global equity markets are continuing to trend upward. As equity markets are a leading indicator of growth, this trend should underpin further gains in AUD in Grace's view.
In coming months, Grace expects Australian interest rates will re-price Reserve Bank of Australia (RBA) rate rises. He suggests recent declines in short-end interest rates have been the result of a fall in global bond yields and some bearishness with respect to the Australian growth outlook.
But Grace takes the view the slowing of growth in the Australian consumption sector has not been all bad, as it is coming at the same time as Australia's terms-of-trade hits record highs. If household consumption was also strong there would be too many inflationary pressures, so the below trend growth in the household sector is creating space for above-trend growth in business investment.
Any easing in global risk aversion should see Australian interest rate markets wind back the pricing of rate cuts, something Grace expects will generate some upward pressure for the Aussie dollar.
What also points to a stronger Australian dollar is the currency's exchange rate volatility remains low, as the Australian credit market has been largely unaffected by the issues in specific eurozone credit markets.
Grace notes in such periods of low volatility, relative economic health drives the direction of currency markets. This implies some additional upside for the Australian dollar given the relative health of the Australian economy remains good.
At the same time, Grace sees mounting downside risks to the US dollar outlook. One is from a slowing US economy, which is putting the introduction of QE3 under consideration. The second is the risk of a downgrade to the US's sovereign credit rating. As Grace points out, downside risks for the greenback represent upside risks for the Australian dollar.
Grace expects buying by unhedged local institutions and exporters will limit any Australian dollar downside. Most local offshore asset managers have either reduced hedges or allowed hedges to roll-off as the Aussie dollar wasn't expected to remain above parity for as long as has been the case. This is forcing some buying and should continue to support the currency in Grace's view.
Looking forward, Grace expects the Australian dollar will hit fresh post float highs above 1.1012 against the US dollar, with 1.12 a likely target.
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