There have been a lot of questions around the Australian dollar’s persistence and strength above 70 cents as commodity markets crashed recently.
Many theories have been proffered. But for the most part the fact that many pundits have been surprised by the move is in itself a potential cause of the move. That’s because this surprise reflects market positioning which had baked the move to 65 cents in coming months into the cake.
That made a higher Australian dollar the “pain trade” for the investors and traders who had sold the Aussie (what traders call shorts) regardless of the deterioration in fundamental drivers. All it needed was a little less selling or some renewed buying from offshore to produce a turn in the trend.
In a note to clients, Westpac’s chief economist Bill Evans said that he finds himself among the cohort of “surprised” pundits in the last few week’s move in the Aussie dollar from 70 to 73 cents against the US dollar.
“Over that period the USD price of our key commodity export, iron ore, (20% of our overall export price Index) has fallen by nearly 20%,” he said.
This makes his call the Aussie dollar will fall to 68 cents by year’s end “vulnerable”.
But he’s not backing away from his view that the dollar is going lower. Evans says the market has become obsessed with the idea that it’s only RBA moves that influence the exchange rate between the US and Australia.
That, he says, ignores the reality that “a Fed rate hike will have a similar impact on AU/US rate differentials as an RBA cut”.
He added that because it has been so long since the Fed moved rates, let alone increased rates, that this month’s expected rate rise in the United States, “might see a bigger response in currency markets than is currently expected as markets adjust to a ‘new set of rules'”.
Throw in Evans’ expectation of another move by the Fed in March and the market will need to reappraise the “slope” of the Fed’s tightening cycle. That means the US dollar will get a boost and the Aussie dollar will fall “without any necessary response from the RBA”.
That, along with weak commodity prices, means the Aussie dollar is headed to 68 cents Evans says.
If not before, that combination of December and March FED hikes with a lower trajectory for commodity prices will see the AUD testing our USD 0.68 target by March.