The Australian dollar has been on a tear since early December, rallying close to 8% against the US dollar.
Propelled by weakness in the greenback, higher commodity prices, exuberant investor sentiment and growing expectations that the Reserve Bank of Australia (RBA) will begin to lift interest rates this year, the AUD/USD currently sits at a 4-month high of .8055, seemingly on its way to testing the high of .8124 struck in September last year.
Some think that level will be tested and breached in the months ahead.
However, while others are getting bullish on the Aussie’s prospects, Bill Evans, Chief Economist at Westpac, is not.
He thinks the high-flying Aussie is about to hit some significant turbulence, seeing it fall to 72 cents before the year is out.
That represents a decline of more than 10% from its present level.
The basis for Evans’ call is simple.
He thinks that interest rate differentials between the US and Australia will be far larger than what markets currently expect. Along with an expectation that commodity prices will correct by 20%, he says this will act to reverse the Aussie’s rally.
“Markets are anticipating that the yield differential between Australian overnight rates and US rates will be around –28 basis points by end 2018 whereas Westpac expects a differential of –62 basis points,” Evans says.
Helping to explain why he thinks the spread between overnight US and Australian yields will be far larger than what the markets currently expect, Evans says the US Federal Reserve will increase interest rates three times this year.
In response to [recent weakness in the] USD and the expected impact on business investment from the accelerated depreciation allowances in the US tax package, we have raised our forecast for growth in the US economy to 2.5% from 2.2% in 2018,” he says.
“Lower tax rates, a lower USD and a subsequent 6% lift in the US share market have markedly eased financial conditions despite higher bond rates, clearing the way for a FED rate hike in March.”
Evans is also forecasting additional rate hikes will be delivered by the Fed in June and September of this year.
In contrast, as the Fed hikes rates fairly aggressively, Evans says the RBA will keep the cash rate unchanged at 1.5%, partially in response to renewed commodity price weakness.
“Westpac retains its call for RBA to remain on hold through 2018 while we retain our end-2018 forecast level of the Commodity Price Index still indicating around a 20% fall in the Index,” he says.
According to Thomson Reuters, the median analyst forecast is for the AUD/USD to finish 2018 at 77 cents.
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