UBS: The Australian dollar isn't overvalued -- but that doesn't mean it won't fall

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On the back of further monetary policy easing from major central banks, improved investor risk appetite, lowered expectations for US rate hikes and a rebound in commodity prices, the Australian dollar has ripped higher since mid-January, rallying as much as 10% against the US dollar.

The renewed push higher has some analysts, and even some influential policymakers, twitchy on the prospect of further gains, leading to renewed calls for further rate cuts from RBA to halt the Aussie’s ascent.

While others think the case for the RBA to act is growing, Scott Haslem, George Tharenou, Joakim Tiberg and Jim Xu of UBS Australia don’t believe the Aussie is out of whack with fundamentals at present, suggesting that is currently at “fair value”.

“Despite recent renewed global easing pressures, the AUD’s current level around USD0.75 is ‘fair’ based on the recent jump in commodity prices, led by a surprisingly sharp jump in the price of iron ore, and the recent widening of Aussie (real) bond yields to their global peers,” say the quartet.

“That the AUD has risen on ‘fundamentals’ tends to lessen the likelihood the RBA would pre-emptively cut rates near-term to try and return it to around its recently lower USD0.70 level.”

Haslem, Tharenou, Tiberg and Xu point to the chart below to back their call, suggesting that the Aussie sits within its fair range value at present based off a replication of RBA modeling.

UBS note that “more aggressive AUD jawboning by the RBA [talking down the currency] align with the periods the AUD were materially outside the RBA’s own AUD ‘fair value’ model, particularly in late 2012 and mid-2014”.

The absence of jawboning from the RBA over the past 18 months “marries with the AUD inside its fair value range, and quite close to fair value for much of the year”, say UBS.

Though it remains around fair value at present based on their own modeling, that doesn’t mean that UBS doesn’t think that the Aussie will fall in the months ahead. They do.

“Given the likelihood the recent pick-up in iron ore demand around China’s new year celebrations will wane – and temporarily slower supply will reaccelerate – our commodity analysts continue to expect iron ore prices to correct lower to around US$45 by mid-year,” say the quartet. “We also expect that the US Fed will retain two of its ‘dots’ next week, against market pricing for virtually no Fed hike in 2016, leading to some reversal in US front end rates. Indeed, we expect the real yield spread between the US & Australia to end 2016 closer to zero.”

Based on this view and the likelihood of “less buoyant Australian data over the coming 6 months”, they expect the AUD/USD to slide to 70 cents by the end of June, extending that decline to 68 cents by the end of 2016.

Currently the AUD/USD buys .7490.

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