MORGAN STANLEY: The Australian Dollar Will Hit Parity By Year's End

Analysts have turned everything you thought you knew about the AUD’s trajectory on its head (Photo: Getty Images)

Most Australian dollar forecasters expect the currency will head lower over the rest of 2014 and then into 2015.

But not Morgan Stanley, which says the Australian dollar will reach parity with the USD by the end of 2014 in its latest outlook note.

They are basing this prediction on Australia’s relatively high, by G7 standards, interest rates and triple A credit rating.

From the note:

The main driver of our bullish stance is our expectation that global demand for high-yielding AAA paper will result in further strong inflows to Australia. And with gross issuance around AUD 5.5 billion a month, there’s plenty of fresh debt for global
investors to buy.

This is a “carry” trade, Australian style.

That is, investors and traders from offshore who are unable to find a decent interest rate in their home market, and unwilling to commit to stocks, invest their cash into relatively high-yielding currencies (like the Aussie) and fund, or borrow, out of low interest rate regimes like Europe, the US and Japan.

Morgan Stanley says it was these big portfolio flows — as foreign investors bought Australian dollars — which drove the AUD in 2010 and 2011 on their own, unrelated to economic fundamentals.

As a result Morgan Stanley is not worried about the fall in the terms of trade saying this is a fact, or expectation, that is already priced into market and so is baked in the cake.

In particular the bank says Japanese buyers are returning, and have bought “$10.9 billion of AUD assets, having previously sold AUD 34.2 billion in the 11 months ended September 2013”.

Indeed even a casual observation shows that this chart is starting to look like the volume of buying which aided persistent Australian dollar strength in the 2010/11 period when the currency went all the way to 1.1080.

In making its case for continued carry buying and no cut in RBA interest rates, Morgan Stanley highlights the strength of the Australian economy and in particularly the fact it believes the “Capex Cliff (is) Being Delayed”.

It’s analysts say “the uplift in 2014/15 capex outlook was primarily driven by non-mining sectors, particularly retail and real estate”.

Turning to the fall in commodity prices and Australia’s terms of trade, Morgan Stanley recognises that national income is not just about price or volume but a combination of both.

So even though prices are lower it says there is a “once-in-a-generation contribution to growth from net exports that is taking place right now.”

It all adds up to a convergence of positives according to Morgan Stanley which will drive the Aussie to parity against the US dollar by the end of 2014 before it drifts off in 2015 – partly on the RBA’s need to ease rates to mitigate the strong Aussie dollar.

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