Morgan Stanley says the Aussie dollar will fall to 65 cents in 2016 - here's why

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Morgan Stanley has the most bearish forecast for the Aussie in 2016 I have come across so far.

The bank’s Global Currency Research Team, in their monthly FX-Tract publication, says the AUDUSD exchange rate will fall to 65 cents by December next year.

That is way below what the market is pricing via forwards and also well below consensus forecasts.

Key to Morgan Stanley’s bearishness is that they believe Chinese growth is both slowing and changing.

The report said “not only is the government attempting to rein in lending and prevent excessive hot money inflows, but it is also moving towards establishing a sustainable growth model less dependent on investment, exports and leverage”.

That means the current Chinese economic slowdown will continue and Morgan Stanley believes that “such developments would affect Australia disproportionately, given the country’s heavy reliance on exports into China.”

As a result, Australia’s terms of trade will fall further and, echoing comments the Reserve Bank has been making about valuation, the report highlights that:

The gap between Australia’s real effective exchange rate and the country’s terms of trade remains very wide, and alone suggests that risks are skewed towards further currency weakness.

The RBA will be pleased at this prospect.

What won’t please the RBA however is that Morgan Stanley says the handover from the mining boom to a broader economic recovery is “at risk of stalling.” That “challenges the RBA’s forecast for an eventual recovery in non-mining investment”.

Morgan Stanley believes it is this combination of a slowing China, weak domestic economy, “rich valuations”, a “stalling domestic economic transition” and an RBA with an easing bias which will drive the Aussie dollar to 65 cents.

The good news is, if they are right, a lower Aussie dollar will go some way in helping the economy rebalance.

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