ANZ: The Australian dollar is likely to tumble in the year ahead

Photo: Miguel Villagran/ Getty.

The Australian dollar is likely to hit a cyclical low of 64 cents in the September quarter of 2016, with recent strength – seemingly running against fundamentals – unlikely to be sustained in the months ahead.

That’s the view of Daniel Been, currency strategist of the ANZ, who suggests the terminal level for the Aussie is likely to be closer to 60 cents rather than 70 cents.

He suggests that the recent rally in the Aussie, something that took the currency from a low of .6893 in September to a high of .7385 in early December, is unusual as it occurred with seemingly little fundamental support.

“Of 22 short term fundamental and market-based factors which have significant medium term relationships, none are currently driving the AUD,” said Been in a note today.

Instead, he suggests an increased belief that a potential US interest rate hike won’t be disruptive to markets, along with recent improvement in Australian economic data, is likely behind the recent rally in the currency.

Certainly improved domestic data, something that has seen markets lessen the likelihood that the RBA will reduce interest rates further in the new year, has supported the currency on a pure yield differential basis.

However, Been suggests the diminished likelihood of further easing from the RBA is unlikely to remain a positive driver of the currency, with structural headwinds for the economy likely to see interest rates lowered further, adding to downside risks for the currency.

ANZ is now only one of a handful of firms predicting that the next move in the cash rate will be lower, forecasting that the RBA will cut rates by 0.25% in May 2016.

Been suggests at its present level, the Aussie is now more overvalued than at any point in the past two years.

“On a medium term basis, the recent move has created a divergence from fundamentals that is even larger than that seen when the AUD was at USD0.92 in March 2014. This overvaluation is evident no matter which way you cut it. In a traditional model (which integrates the terms of trade, rate differentials, and a risk factor) fair value is now at USD0.62,” says Been.

“This again confirms our bias that the rally in the AUD has been both excessive and too narrowly driven given the deteriorations being seen in a broader framework.”

The chart below, supplied by ANZ, tracks movements in the Aussie against ANZ’s fair value model. A significant gap has now opened up between the currency and its perceived fair value, according to metrics used by ANZ.

“Given the work we did on overshoots and the balance of risks, this leaves us comfortable with our forecast that the AUD will overshoot fundamentals and that our target of USD0.64 remains a real prospect,” says Been.

He suggests this level is likely to be reached in the September quarter next year before the currency gradually moves higher over the course of 2017.

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