- UBS says this year’s 12% fall in the AUD has been driven by global factors.
- They said there’s no material correlation between the AUD’s decline and domestic economic risks stemming from falling house prices.
- UBS expects the AUD to finish the year higher than where it is now.
The Australian dollar has now fallen by 12.3% from its 2018 high. But the falls have been driven more by external factors rather that domestic risks, UBS says.
Trade tensions, strength in the US dollar and concerns about emerging markets have all served to weigh on the Aussie this year.
Turning their focus to the Australian economy, the UBS global macro team assessed whether Australia’s ongoing housing downturn had also served to weigh on the currency.
The answer? Not really.
What caught their interest is that the AUD’s decline has coincided with the commencement of the banking Royal Commission in March. Since then, tighter lending standards have led to a slowdown in credit growth.
So the bank’s analysts took a closer look at whether the knock-on effects from falling house prices — a declining wealth effect and lower consumption — was also driving the Aussie lower.
The analysts found that there’s “little evidence of an economically valid relationship between the AUD and credit or housing prices, while the correlation between the AUD and home loan approvals is insignificant”.
What about domestic interest rates? Yields on US treasuries now exceed that of Aussie government bonds, which historically has been a drag on the Aussie. And UBS noted that a similar pattern is now starting to play out:
In addition, interest rates are partly a function of how the economy is performing. So the analysts looked at the extent to which falling house prices have influenced market expectations for RBA monetary policy.
It turns out that RBA rates expectations “have moved with house prices in the past, but rates now appear to be less sensitive than in previous housing slowdowns”, UBS said.
“This is perhaps because the housing slowdown so far has been concentrated in investor lending and investment properties, and has been driven largely by regulatory changes.”
In addition, they said rate expectations were also influenced by international factors, such as Chinese growth expectations. To demonstrate, they highlighted a correlation between market pricing for RBA rates and Chinese stocks:
“We think it is hard to pin the repricing of RBA expectations squarely on the housing slowdown, but it may matter at the margin,” UBS said.
“Critically, we do not think that the softness in housing will become material enough for the RBA to cut rates, therefore the curve is unlikely to reprice lower.”
Instead, “the external environment has remained a key driver of AUD weakness”. And viewed within that context, the analysts expect the AUD to finish the year higher than it is now.
They said the domestic economy will continue to “muddle through”, as falling house prices are offset by strong infrastructure spending.
And globally, China’s envinromental focus will drive demand for high-quality Australian iron ore. In addition, UBS appears relatively unphased by the prospect of a US-China trade war.
“If and when trade tensions and Chinese growth concerns fade, we believe these more positive AUD fundamentals are likely to lead to a stronger currency,” they said.
Turning back to housing, the analysts said it won’t be smooth sailing in the months ahead. They cited the example of Sweden, where a housing downturn dragged the economy down and had a material effect on the currency.
For that to happen in Australia, UBS said house price falls would have to start weighing on consumption.
Key factors to monitor include: more out-of-cycle rate hikes, enforceable debt-to-income limits which further slow credit growth, and potential policy changes stemming from a change of government at the next federal election.
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