Despite falling in recent days, the Australian dollar has enjoyed a stellar recovery from the lows seen earlier in the year.
From January 15, a period when the markets thought the Chinese economy was going to implode, the Aussie has rallied by over 10% against the US dollar.
As soon as they arrived, fears surrounding the Chinese economy were pushed to the wayside, replaced by a global chase for yield that saw the Aussie rocket to as high as .7835 over the next three months.
While there were many factors that led to that near-15% recovery — better Chinese data, surging bulk commodity prices and reduced financial market volatility just to name three — another major reason was a sharp about-face from the US Federal Reserve when it came to the outlook for interest rates.
From the possibility of a couple of rates cuts being delivered this year, market probability went to none, assisting the Aussie’s move higher.
Now, even with only a small probability of a rate hike being delivered by the Fed in September, the National Australia Bank’s FX strategy team, led by Ray Attrill, believe the Aussie could be about to re-test the highs of April should the Fed leave interest rates unchanged next week.
“Much now depends — as it has all year — on the Fed,” strategists at the bank wrote in research note released on Monday.
“Inaction this month should see us back above 0.77, a rate rise back down below 0.75, and probably sub-0.74. If the Fed is not going to move on rates this month, there’s a strong chance the highs will be tested before September is out.”
Even before a potential shift higher, the NAB believes the Aussie — at its current level — is still overvalued based on its own internal modelling.
“Our short term fair value estimate currently pegged at 0.722. Moreover, updating our stylised RBA equilibrium exchange rate model (for the real trade weighted AUD) we detect a further widening in the gap between the actual level of the real TWI [trade-weighted index] and the model value,” the bank wrote.
“So while RBA Governor Glenn Stevens, in a valedictory interview with the AFR last week, said that his ‘position in recent times has been it (the AUD) has been adjusting as it should’, we’d sense that his successor may soon be confronted by Mr Stevens’ warning in the same interview that ‘it’s possible it will give us trouble’,” it adds.
In recent months the RBA has stated that a higher Australian dollar could “complicate” Australia’s economic adjustment.
Should the NAB be correct on its near-term outlook for the currency — and let’s be honest, the markets don’t think there’s much chance that the Fed will hike rates next week — it would certainly complicate Philip Lowe’s first policy meeting as RBA governor, and adds intrigue to what changes he may make, if any, to what was communicated by Glenn Stevens one month earlier.
Here’s a chart from the NAB that looks at the Australian dollar real trade weighted index, based off a replication of RBA modelling. At present, the currency is trading significantly above its equilibrium value, something that in the past has heralded “jawboning”, or talking down of the currency, from RBA officials.
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