MORGAN STANLEY: The Australian dollar is heading back to 70 cents

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The Australian dollar has opened trade around 0.7540 for the week.

That’s a little less than 2 cents below this month’s high of 0.7721 after the Aussie spent the last week under pressure as traders rethink the outlook for the economy and RBA interest rate settings.

That weakness is just a precursor to a deeper fall, according to Morgan Stanley analysts Jessica Liang and Charles Rubenfeld.

While Liang and Rubenfeld believe, because of their bank’s short term bearish US dollar view, that the Aussie might rally back toward the 77/78 cent region, they say this will be an opportunity to sell Australian dollars and “look for a structural move downwards, targeting 0.70”.

Liang and Rubenfeld are skeptical of Australia’s economic outlook and believe the economy needs a lower dollar to support growth.

“We do not believe the Australian economy has turned the corner and expect more weakness ahead, leading to RBA rate cuts and a weaker AUD,” they said.

Liang and Rubenfeld echo RBA governor Glenn Stevens’ comment in his statement last week that “an appreciating exchange rate could complicate the adjustment under way in the economy”.

The weaker Australian dollar has been integral to the economy’s relative strength over recent years, Liang and Rubenfeld say. But that could now be a handbrake on growth, especially for the services sector:

Australia still needs a weaker AUD to boost growth. Net trade has added an average of 1.5% to GDP in the last two years as the real trade balance has improved significantly, offsetting the nearly-identical drag from an investment (ex. dwellings) hit to GDP during that time. Exhibit 2 shows the net trade contribution to Real GDP growth has been largely driven by moves in the AUD TWI. With the AUD TWI now about 2% above 4Q levels, net trade can easily turn into a drag on GDP if AUD does not depreciate from here. This poses a particular problem for the labor-intensive services exports (such as tourism) which have recorded especially strong growth recently.

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But even though trade has been a net positive for Australian growth recently, “the current account deficit remains one of the largest in the world at 5.1% of GDP(4Q15)”, they said. That requires a lower Aussie to address this problem.

Other reasons Morgan Stanley is bearish the Aussie include the rebalancing of the Chinese economy which “is a net negative for Australia”. Indeed, the bank says the end result of a successful rebalancing in China is that it “inherently puts Australia in a low growth trajectory all things equal”.

Liang and Rubenfeld also believe the slowdown in housing construction, which has “been a key factor offsetting the fall in commodity-related capex”, has peaked, putting further downward pressure on capex. Combined with “softer house prices”, which will weigh on consumption, the result is a slowing Australian economy.

The fact that “AUD long positioning near the highs of the last three years” along with sentiment which “has rarely been more bullish”, means the Aussie “is susceptible to a reversal,” Liang and Rubenfeld added.

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In the end, Morgan Stanley’s synopsis appears to be that all the good news is priced into the Australian dollar at the moment and the risk are the now skewed to the downside.

Some cracks are beginning to show in the data and in the RBA’s hawkish tone. In the last week we have seen disappointing retail sales, trade data and falling building approvals, all pointing to a weak 1Q. The RBA’s recent statement’s negative reference to AUD, the first since July-15, puts the AUD back in focus and opens the door for further rate cuts if data remains weak. Our economists believe the early budget makes May unlikely, but the risks rise as AUD stays elevated.

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