- The Australian dollar has been strengthening in recent weeks, recovering after a steep drop earlier in the year.
- Bank of America Merill Lynch thinks there’s more upside to come for the Aussie, and not just a little but a lot.
- It is forecasting the AUD/USD trade in the mid-80 cent region next year.
After a torrid start to the year, seeing it slide 9% against the US dollar in a little over three months, the Australian dollar has found its footing in recent weeks, lifting to .7580, up over 2% since May 9.
It’s also managed to bounce against other major crosses during this period, increasing by 2.1% in trade-weighted terms.
Bank of America Merill Lynch (BAML) FX Strategist Adarsh Sinha thinks there’s further upside to come.
And not just a little but a lot.
“AUD underperformance is near its end, in our view,” he said in note dated May 24.
“Having reached our 0.7500 target for Q2 2018, our forecast profile is also bullish AUD/USD over the longer term, targeting a move toward the mid-0.80s by 2019.”
Sinha is also bullish Aussie against the crosses, suggesting the AUD is close to its trough in trade-weighted terms and unlikely to test the lows of 2015.
The RBA’s AUD trade-weighted index (TWI) fell to as low as 59.2 in early September 2015, below the 62.9 level where it currently sits. Its recent trough was 61.60 struck on May 9 this year.
A major factor underpinning Sinha’s bullish call is the opinion that pessimism towards the Chinese economy, Australia’s largest trade partner by some distance, is now priced in.
“The China backdrop remains negative but appropriately priced,” he says.
“The AUD trade weighted index is trading close to its lowest level since 2015-16, a time when the China macro backdrop was more negative.”
Singa says the Aussie is also undervalued relative to interest rate differentials and terms of trade.
“A common refrain is that the compression of Australia rates relative to the rest of the world means the AUD should underperform. The 2-year differential with the US, for instance, is at its lowest since 2000 when AUD/USD was close to 0.50,” he says.
“This partial analysis glosses over the fact that Australia’s terms of trade is substantially higher than it was back then.”
Adding another tailwind to further Aussie dollar appreciation, Singa, in contrast to the vast majority of analysts, believes the RBA could actually lift interest rates sooner than markets currently expect.
“In our view, market pricing of a full rate hike only by August 2019 is taking an excessively cautious view on policy normalisation,” he says.
“At a time when forward looking indicators for the labour market are positive and with the RBA’s liaison program already showing tentative signs of wage growth, it seems a strong assumption that the RBA will not shift to a tightening bias until well into 2019.”
According to latest forecasts offered to Thomson Reuters, the median AUD/USD forecast for 12 months time currently sits at 78 cents.
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