Currencies | May 17 2013
– USD strength knee-jerk
– US deficit still a headwind
– Australian trade and yield still currency supportive
By Andrew Nelson
The recent fall in AUD has been cheered by most across the Australian market and analysts are even starting to talk about newer and better models if the trend is sustained. The problem is, currency analysts at Commonwealth Bank think this time in the sun will prove fairly mild and short lived.
The bank argues that by far the most significant reason for recent AUD weakness is nothing more than recent and what should prove temporary USD strength.
Some believe the recent USD resolve is due to the market lining up to pick up cheap greenbacks ahead of the Fed’s move out of QE sometime in the possibly not too distant future. A number of market participants see the Federal Reserve signaling at least a tapering of asset purchases sometime soon and the US 10 year bond yield has already lifted 30bps to 1.97% since the end April. This would imply the USD will continue to firm as the Fed starts easing.
CBA disagrees, noting he USD is facing a number of headwinds that the bank thinks will cause it to soften again and not too far into the future. The bank cites a large current account deficit, negative real interest rates and a fiscal policy, which despite all of the talk, is still on a tightening bias.
Also, there really hasn’t been that much of a change to the underlying macro picture. CBA expects Ben Bernanke to throw some water on the fire next week when he speaks on the US economic outlook and the latest FOMC minutes may also cool the mood. This should put a lid on all of this talk about the Fed soon tapering off its asset purchases, says the bank.
This should also quickly lead to a softening in the USD and firming in the AUD. The bank goes so far to say that it would be unsurprised were Uncle Ben to remind the market of his already stated opinion that US fiscal tightening will carve 1.5 percentage points off US GDP growth this year.
And that’s just one of the issues facing the greenback. CBA points out that the US current account deficit is running at 3% of GDP, not great if you want a strong currency. The broker also doubts the US will be lucky enough to experience some sort of gas-led economic recovery that could potentially reign in the current account deficit over the next couple of years.
The next issue the broker sees is that US real interest rates remain negative along most of the yield curve. CBA points out that the greenback has historically struggled to rise when real rates are negative. The only exceptions are brief safe-haven spikes when things look tougher elsewhere. Sound familiar?
Thus with real interest rates in the US likely to remain negative, which is something even the Fed expects, and with the US economy not heading much of anywhere anytime soon, CBA just can’t see how the greenback will keep rising. And if the USD isn’t rising, the AUD will, predicts the bank. This being the case, CBA warnsnot to pay any attention to comments from the more hawkish members of the FOMC.
As with all coins, there is another side to this picture. As while the bank expects the USD to weaken given the rationale above, it also sees more general factors emerging that should prove supportive of the AUD. Firstly, despite the recent rate cut, Australian yields are running much higher than the US. Terms of trade are still at some very high levels as well, which is also supportive for the AUD.
CBA also sees some significant pent-up demand for the AUD from foreign central banks. The bank reports a survey of 64 central banks shows a significant number are looking at increasing their exposure to commodity currencies like the AUD and CAD. Both currencies are not only attractive in their own rights, but are also seen as a sound proxy for rapidly expanding Asian emerging market economies.
What to do? Buy the Aussie against the USD now that it’s a little cheaper, because it’s going to go right back up. At least that’s what CBA thinks.
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