LIFT-OFF: CBA sees the Australian dollar at 80 cents

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While most FX forecasters continue to see the Australian dollar moving lower in the years ahead, that sentiment is not shared by the Commonwealth Bank. In a major deviation from market consensus, the bank has turned bullish towards the Aussie, predicting that it will be back at 80 cents by the middle of next year.

Yes, not only has the AUD’s lows been hit, there are further gains to come in the opinion of Australia’s largest bank.

The bank’s chief currency strategist, Richard Grace, believes there are four factors that will work in the Aussie’s favour in the year ahead: Australia’s economic resilience, a bottoming out in global commodity prices, lowered expectations for US rate increases and an expected improvement in Australia’s current account deficit.

Grace believes the recent strength in the Australian economy will not only endure, but improve further in the years ahead.

“We anticipate Australia’s economy to further accelerate in 2016 and 2017, with Australia’s unemployment rate to further decline to an average 5.6% over 2016 and 5.3% over 2017,” says Grace.

He also notes that global commodity prices “appear to be in the process of bottoming out”, suggesting that it is advancing at a more rapid rate than the bank previously anticipated thanks in part to a weaker US dollar.

“Australia’s terms of trade will endure a lift in the current March quarter and, we believe, stabilise in subsequent quarters,” says Grace. “Australia’s terms of trade remains one of the best long-run guides to the AUD and suggestive of good support for the AUD.”

The chart below, supplied by Grace, reveals the historic relationship between Australia’s terms of trade and movement in the Australian dollar.

Adding further support to the Aussie, Grace suggests that the current US rate hiking cycle — started in December last year — will be far less aggressive than the CBA first envisaged, adding to the case for a higher Australian dollar as a consequence.

“The softening in the US economy since the Fed first lifted interest rates in December means we now believe the Fed will deliver only two further interest rate rises this year, not three, and we have factored this into our estimates of the forthcoming Australia-US two-year bond spread, which is now marginally higher,” he said.

Finally, Grace believes that Australia’s current account deficit will also narrow this year and next, predicting it will fall from its current level of 5.2% of GDP to 3.7% and 2.7% of GDP in 2016 and 2017 respectively.

“Two factors driving a structural improvement in Australia’s current account deficit are a better trade balance as LNG export volumes increase, and low debt-servicing requirements as interest rates remain historically low,” suggests Grace.

As a consequence of these four factors, the CBA’s FX strategy team now predict a steady appreciation in the Australian dollar over the next 15 months.

By the end of 2016 the banks sees the AUD/USD trading at 78 cents, more than 10% above its previous forecast of 70 cents. Beyond that, the bank sees the Aussie trading back at 80 cents by June 2017.

To put that forecast into perspective, Thomson Reuters has the median market forecast for the AUD/USD looking 12 months ahead at 70 cents.

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