NAB: The Australian dollar is 'fairly priced but fragile'

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After the Reserve Bank cut rates in May, market forecasters fell over themselves to downgrade their expectations for a low point in the cash rate for this cycle, plus the value of the Australian dollar.

Figures of around 1% and below 65 cents were freely bandied about.

Deutsche Bank’s currency team even went so far as to say that the Australian dollar is nearly the most overvalued currency in the world, with only the Hong Kong dollar eclipsing it.

The key reasons Deutsche Bank saw the Aussie falling was that “bond inflows to Australia are likely to fall off a cliff even before the RBA cuts rates toward 1%. A possible Labor win in July could dampen house price inflation. Externally, commodity prices and global risk should deteriorate as China slows.”

Yet while the Aussie made a low of 0.7143 around the time of the DB note and comments by RBA governor Glenn Stevens that inflation was on the low side, it is back above 73 cents today.

That’s the first time the Aussie has bested that level since May 18 says Rodrigo Catril, currency strategist at NAB in Sydney.

Catril also noted that the combination of factors which are inputs into the bank’s model of the estimate of AUD/USD fair value suggests a price of 0.7440 against the current spot of 0.7340. He says the difference in price between spot and the estimate is statistically insignificant in terms of the model.

But the NAB’s model is a coincident fair value estimate – that means it is driven by observable market prices at the time of calculation such as interest rate differentials, commodities, investor risk appetite among others. So Catril says that with the many headwinds facing global markets the Aussie is unlikely to be able to sustain levels above 74 cents.

“Ahead of the UK referendum we expect choppy market conditions as liquidity dries up and investors sit on the sidelines. We are also closely monitoring risk sentiment and commodity prices. The VIX is currently trading close to the bottom of its 13-16 range held since mid-March and a move back towards/above the upper edge of this band would be expected to weigh on the AUD. Similarly, iron ore prices looks susceptible to the downside,” he said.

So the Aussie dollar remains relatively high, but fragile in the view of Catril and his colleagues at the NAB.

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