The Australian dollar has fallen 11% since January. We still see AUD falling to 69c in the short-term on trade tensions and higher U.S. interest rates but longer-term, we expect AUDUSD to head back towards 80c. Key factors we see supporting AUD is the additional stimulus coming from China’s policymakers, firmer commodity prices and the next move on interest rates by the Reserve Bank of Australia (RBA) will be up.
As we’ve mentioned previously, we don’t expect U.S. interest rates to go much higher after the Federal Reserve’s December meeting. However, we expect the RBA to begin tightening rates by late 2020 as the central bank is currently in no rush given low inflationary and wage pressures along with a weakening housing market. Longer-term, with the U.S. fiscal stimulus wearing off and falling rate differentials between U.S. and Australia, this represents an ideal time to take advantage of a likely AUD recovery.
China’s large stimulus package was used to partially offset the trade war impact and the results of this are likely to show up this quarter. Furthermore, China’s Blue-Sky strategy is seeking out high-quality and efficient raw materials in an effort to improve air quality and improve efficiencies of energy-intensive industries. This should keep iron ore prices elevated and improve Australia’s terms of trade as iron ore is Australia’s largest export. Although China’s Ministry of Ecology and Environment imposed capacity cuts, leading to less steel being produced and decrease demand of iron ore, demand and therefore prices for Australia’s ‘high-grade’ iron ore are expected to increase as higher-grade iron ore boosts productivity and steel mills emits lower emissions. Therefore, the stimulus package and increase demand for commodities will also strengthen the AUD.
Short-term risks for AUD will be if sentiment towards China turns negative if the planned President Trump – President Xi meeting during the upcoming G20 summit in Argentina in late November yields further trade attacks. If further tariffs are imposed on Chinese goods exported to the U.S., this could decrease demand for commodities leading to falling prices, hurting Chinese exports and economic growth.
While we see AUD recovering longer-term, any gains will be tepid by interest rate differentials and the level of household debt. The RBA has kept rates at 1.5% for 27 consecutive meetings while the Federal Reserve and the Bank of Canada have raised rates to 2.25% and 1.5% respectively. We expect rates in these countries to increase to 2.5% and 1.75% before the RBA itself begins to raise rates. On this basis, foreign investor inflow will be lower and will keep a lid on AUD appreciation.
Australia’s household debt to income levels is one of the highest in the world making the economy more vulnerable to a downturn. Household debt in Australia is currently at 190% and a tighter monetary policy may expose banks to a ‘credit crunch’, leading to higher lending repayments and consequently, a slowdown in income growth and consumer spending. Which is why the RBA is unwilling to increase rates as any hard-landing will push the AUD down sharply.
The past four months the AUDCAD has fallen to a recent low of 0.9105. We feel there is long-term scope AUD to rise against the CAD over the coming weeks as the CAD is expected to remain flat against the USD given the widening gap between U.S. and Canadian interest rates. With the Bank of Canada meeting this week, we expect a 25 basis point hike which may result in a small boost to the CAD. However, longer term, we expect USDCAD to remain rangebound between 1.28 to 1.31 and AUDCAD to increase by around 4% during the following months.
Overall, we believe most of the bad news has been priced into the AUD and normalisation in monetary policy will not occur until at least after the next federal election. Current levels represent an ideal long-term buying opportunity against CAD and USD however, there are a number of short-term catalysts that could send the AUD lower.