Currencies | May 29 2013
– CBA now expects rising USD, falling AUD
– UBS and Credit Suisse also cut AUD forecasts
– AUD down to 95c by end of September says CBA
– Credit Suisse sees 85c within 12 months
By Andrew Nelson
The week before last currency analysts at Commonwealth Bank suggested the sinking AUD was a simple function of a rising USD and that the trend would be brief. Last week the same team changed course, revising down AUD forecasts for a number of reasons, the main one being a decline in Australia’s terms of trade. The bank has lined up a laundry list of reasons, of which falling terms of trade is just one.
CBA leads off with a backdrop that has been discussed for some months: increasing global commodity supply and slowing global commodity demand. While this has certainly been generating downward pressure on commodity export prices, CBA has now noted the impact this is having on Australia’s terms of trade.
The bank reports that all of the global base metal markets are currently in surplus, except tin, and this is putting significant downward pressure on global base metal prices. While broader base metal weakness will undoubtedly have an impact on Australian exporting, the real issue is arising from price weakness in the two of the main drivers of Australia’s terms of trade, iron ore and coal.
On CBA’s numbers, iron ore accounts for 26% of exports and coal 18%. The global coal market is already in surplus, while CBA expects the global iron ore market to move into surplus over the next six to twelve months. Prices for both have come off since the beginning of the year and this has helped to pull down Australia’s terms of trade by 17% since the peak in September 2011.
Admittedly, the declines in the nation’s terms of trade to date have so far generated only minor downward pressure on the exchange rate. But increasing expectations for further commodity supply to come on-stream is pointing to further declines in Australia’s terms of trade and thus a weaker AUD.
The second reason is US GDP growth and the near-term forecast for US GDP growth. Right now US GDP forecasts are significantly outrunning those for the other G7 nations. This is helping to generate and support the current broad-based USD strength. And while it is inarguable the US economy is still facing numerous fiscal headwinds, CBA believes the US economy will expand much more quickly than the other G7 members. This means a stronger USD and conversely, a weaker AUD.
CBA also notes the recent, if contradictory, rumblings about the US Federal Reserve’s monetary policy intentions. While we’re likely still a ways from seeing an end to it, CBA along with an increasing number in the market are of the view the Fed is at the bottom of its easing cycle. The bank expects the Fed to begin winding down asset purchases, with an end now expected in March 2014. The bank also expects the Fed to lift the Fed funds rate by the end of 2014.
At the same time this is playing out, the RBA remains in the midst of an easing cycle. Thus, the divergence in monetary policy is also creating downward pressure on the AUD/USD. And if you add together a firming USD and the fact that the European Central Bank, Bank of England and Bank of Japan all still remain in easing mode and you’ve got an even stronger USD and conversely a weaker Aussie.
The next factor is one not so much depressing the Aussie vs the USD, but rather holding it back from clawing back ground. Given the divergence in the easing cycles between the Fed and the rest of the G7, CBA noted most of the upward adjustment pressure on US interest rates relative to Australian interest rates is occurring through the ten-year bond spread. CBA says the adjustments are bigger at the ten-year end of the bond curve because of the Fed’s intention to keep the Fed funds rate at very low levels. This, in turn, is preventing a large relative adjustment at the short-end of the US bond curve.
The next AUD issue is declining core inflation in the US. This is making US real yields look much nicer. CBA notes that with the US nominal ten-year bond yield now above 2.0% and US core inflation at 1.7%, US real ten-year bond yields are now positive. CBA notes returns are now at 35 basis points, which is the highest they’ve seen September 2011.
Sure, it will take a much bigger lift in US real bond yields to actually generate significant strength in the USD, but the current lift in the US real ten-year bond yield into positive territory is still USD supportive. The bank also points out the lift in US real yields and the divergence in monetary policies is curbing the demand for diversification into other reserve currencies, like the Aussie.
Global central banks are also buying into the current dip in AUD, but not like they did on AUD weakness back in 2011 and 2012. The bank sees this as meaning that right now, diversification into other reserve currencies has been put on the back burner until market participants assess these increasingly attractive US real yields.
This slowing in reserve diversification, especially into the AUD, is still consistent with the narrowing in Australia’s current account deficit. CBA is now forecasting Australia’s current account deficit will narrow from 3.9% of GDP currently, to 2.3% of GDP. While certainly a symptom of increasing AUD pressure, it’s also this expectation for a narrowing in Australia’s current account that will keep the Aussie from collapsing.
The weakness in the yen and the rising USD has led to a fairly broad-based decline in a weighted basket of non-Japan Asian currencies as well. CBA doesn’t see the Aussie tracking too far from the rest of the region and that’s because more than 76% of Australia’s merchandise trade goes straight to Asia. The bank also notes that historical data show large directional moves in USD/JPY are consistent with large directional moves in the US trade-weighted index.
The last new argument put forth by the team at CBA is that US offshore equity investment has turned negative. This is only the second time this has happened since 1973. The broker believes the US equity market’s recent outperformance combined with the drawn-out eurozone recession has pulled offshore US capital to back to the US market. These inflows are also supporting the greenback and the bank sees this trend continuing to play out over the next few quarters at least, or for as long as the US economy continues to significantly out-performs its G7 peers.
While CBA’s longer-dated AUD/USD forecasts are unchanged, there is some significant downward adjustment on nearer-term numbers CBA now has the AUD at US$0.9900 at the end of June, at 0.9500 at the end of September and at and 0.9600 by the end of 2013.
UBS came to a similar conclusion last week as well, noting that while AUD has weathered commodity price weakness before, current portfolio inflows are nowhere near enough to provide any sort of offset. The broker has the AUD at 0.9500 by the end of the year and at 0.9000 by mid-2014 out to the end of that year. The current 1-month forecast is also down to 0.9500, as is the broker’s 3-month forecast.
Analysts at Credit Suisse also chimed in last week, seeing the AUD at 0.9200 in three months and to 0.8500 in 12 months. What makes CS so bearish? The broker sees USD denominated commodity prices falling by 30% over the next five years.
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