The strength in the Australian dollar against its US counterpart this year has been well-documented, with the most recent surge starting in July.
That took the AUD into the high-US70 cents range, and in late-July it closed above US80 cents for the first time since 2015.
Since then, the Aussie has managed to hold its value in that elevated range. It dipped slightly last night but a short time ago was still trading just below US80 cents.
The Aussie’s recent strength has prompted Westpac’s global head of capital markets strategy, David Goodman, to try and explain the major catalysts behind the Aussie’s 8.3% rise since June.
Goodman breaks down his findings in this useful chart:
“The largest contributor of the AUD move has actually been primarily the weaker USD trend which has dominated markets over the last quarter,” Goodman said.
So in looking at macroeconomic factors behind the Aussie’s recent strength, it’s also important to assess what’s causing USD weakness, and whether those factors will persist.
Goodman said broader US dollar weakness had been driven in part by a more measured outlook on interest rates from the US Federal Reserve, as inflation has remained stubbornly low.
He also cited concerns stemming from political gridlock in Washington, which have delayed the passage of pro-growth fiscal reforms.
However, Goodman noted that last week’s CPI inflation data in the US was solid, just beating expectations. He also said that there’s “glimmers of hope” in Washington regarding the Trump administration’s push to reduce corporate tax rates.
“While September’s projections may migrate in a dovish direction, and uncertainty remains high, we maintain that the Fed will continue gradual rate normalisation over 2018 given full employment; strong job growth; and their expectation that inflation will firm to the target,” Goodman said.
Like the RBA, the US Fed has a core inflation target of 2-3% annual growth.
Goodman also took a more cautious outlook on the Australian economy. He said that a consistent run of poor consumer confidence and low wage growth would likely combine to keep spending and inflation in check.
Combined with “an expected moderation in commodity prices”, Goodman said the potential divergence in the inflation outlook means that market pricing for the future direction of US and Australian interest rates should narrow.
So referring back to the chart above, Goodman concluded that the conditions prevalent for each of the three main catalysts in the Aussie’s recent strength are unlikely to last.
Not surprisingly, at its current level just below US80 cents the Aussie dollar is at the upper-end of Westpac’s fair-value model:
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