Bill Evans reckons the Aussie dollar's days above 70 cents are numbered

Photo by Mark Wilson/Getty Images

It’s been a rollercoaster ride for the Australian dollar in 2016.

After plunging to as low as .6824 in January on the back of heightened fears over the Chinese economy, the AUD/USD retraced that move and more in the following three months, soaring to as high as .7835 in April before easing lower yet again.

Since the giddy ride in the first half of the year, the Aussie has done very little recently, trading in a thin range between .7440 to .7750 for the best part of three months.

In a nutshell, firmer commodity prices have been enough to offset renewed US dollar strength, keeping the Aussie comfortably within this range.

AUDUSD Daily Chart

The question many are now asking is when will this range break, and what direction will it be — to the upside or downside?

That’s exactly what Bill Evans, chief economist at Westpac, has been looking at, piecing together the outlook for interest rates and commodity prices — two key drivers of movements in the Aussie dollar — in order to determine when and where it’s likely to head in the year ahead.

Like the view presented by the National Australia Bank’s FX strategy team earlier this month, Evans believes that when the Aussie does break out of its current trading range, it’s likely to be lower, forecasting that the AUD/USD will finish 2016 buying 74 cents before sliding to 68 cents by the end of 2017.

Here’s his view on the outlook for interest rate differentials between Australia and the US, a factor he suggests will place downside pressure on the Aussie:

With respect to the yield differential story we expect that while markets are currently pricing in around a 50 basis points narrowing of the yield differential between Australia and the US we expect a 75 basis point narrowing. With the RBA on hold and the FED tightening in December 2016 and June and December 2017.

That difference may not seem sufficient to justify a fall in the AUD from USD0.75 to USD0.68 by the end of next year. Part of the story is that US markets are so convinced of a benign US FED in 2017 the realisation that the FED will deliver on those two hikes next year, following December’s hike, will see markets raising expectations for 2018 and, as is the nature of FX markets, that revised profile for the FED will be anticipated upfront in the pricing.

Along with the expectation that markets will start to price in a more aggressive rate tightening cycle next year, Evans expects the rally in bulk commodity prices will reverse in the year ahead, further pressuring the Aussie:

These increases in bulk commodity prices are supply driven they are unlikely to be sustained. We expect supply to adjust to take advantage of the super profits.

We are forecasting falls in iron ore prices (10% in 2016 and a further 10% in 2017); falls in coking coal prices (15% in 2016 and 50% in 2017); and falls in thermal coal prices (15% in 2016 and 15% in 2017).

As a result, Evans notes that taken together, “those components indicate a 30% fall in Australia’s bulk commodity index by end 2017 and a hefty US5¢ fall in the fair value of the AUD”.

The AUD/USD currently buys .7600.

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