The Aussie dollar rallied a little into week’s end, resisting what seemed like a growing sense in the market that it was going to make a new 2014 low last week.
But the resilience of one week doesn’t change the fact that the Aussie dollar’s key drivers of “fair value” aren’t deteriorating, according to Westpac’s head of research Rob Rennie. In a report to clients, Rennie highlighted that Westpac’s “simple fair value model for the A$ has fallen by around 12% so far this year to 0.85 as commodity prices have fallen and volatility has increased”.
But he adds as the ECB is forced toward more monetary accommodation through the provision of liquidity to the market, the yield available on Aussie dollar assets will help the Aussie dollar “remain resilient into year end.”
It might sound like a bet each way but in fact Rennie’s argument is nuanced because, well, currency trading and valuation is nuanced. Rennie’s model is a robust one, with an R-squared of 0.88 using the independent variables to calculate fair value of “WCFIBI index (Westpac’s broader index of Australia export commodity prices, available on Bloomberg), 2-year yield spreads and the VIX”.
But while longer term “fair value” might be lower, the reality is that this is a market environment where the hunt for yield is inexhaustible and Aussie dollar assets are still high yielders.
According to Rennie:
“From a flow perspective we continue to see good investor demand for yield; and as we move beyond this weekend’s ECB asset quality review, we see TLTRO and the various asset purchase programs adding more meaningfully to our measure of global liquidity. That for me is a key driver of why I continue to expect the A$ to remain resilient into year end.”
It seems that forecasts of an Aussie dollar crash may have been a little pre-emptory. At least according to Westpac.