Why the Aussie Dollar Won’t Go Into Freefall

With the Reserve Bank of Australia holding interest rates steady at 1.5% yesterday, the Aussie dollar fell back below 76 cents.

This is in a backdrop of an expected tightening of US interest rates this year by the Federal Reserve.

We always knew at some point US interest rates had to normalise.

However, the Fed is expected to tighten at least two more times this year. That would put the Fed funds rate to 1.5%, or level with Australia’s cash rate.

The prospect of a narrowing interest rate differential between the Australia and the US should weigh down on the Aussie dollar.

Some analysts even suggest interest rates in the US could go higher than in Australia.

It’s not without precedent. The last time it happened, the Aussie dollar plunged as low as US48 cents.

That has led some analysts to say the Aussie is ripe for a fall.

Just don’t expect to see the Aussie dollar to go into a freefall. Not for the immediate future. That’s because Australia is in a unique position. A position it hasn’t seen in decades. Our current account deficit is shrinking.

On the back of soaring commodity prices and rising export volumes, Australia could be on track to post a rare current account surplus this year. The last time that happened, Gough Whitlam was the Prime minister.

The current account numbers are significant for the Aussie dollar. While the Aussie dollar may fall on a closer rate differential with the US, with our current account deficit shrinking, it may fall to a lesser extent than many expect.

The current account deficit shows how much we rely on overseas funding. Currently it’s around 1% of GDP.

That’s not hard to fund.

Current account balances are a big factor in determining currency valuations.

Countries that run current account surpluses have more money going into the economy than leaving it. Global investors see that as a lower risk, due to the lower need for funding.

A current account surplus can provide support for the Australian dollar, and help the Federal Government hold on to its AAA credit rating.

The groundwork for today’s soaring export volumes goes back to 2004–05, a period which saw the building of new mines and the infrastructure put in place to increase the supply of LNG, coal, and iron ore. As demand for commodities has picked up once more, the infrastructure that started to be put in place back then has meant export volumes are higher this time round.

The question is, will it last?

As Australia’s improving current account is dependent on export volumes and commodity prices holding steady, there’s a risk any trade surplus, should it manifest, will not last.

A slowing demand for our resources will cause commodity prices to fall; it also reduces the need for Australian dollars, to buy them.

Demand for our commodities depends in large measure how the world’s second-largest economy is tracking.

A strong Chinese economy is needed to support commodity prices and further underpin the local currency.

Where’s it at?

Industrial output in January and February grew by more than 6%. Electricity generation, power consumption and rail volumes all posted steady growth. The services sector expanded by 8%, and retail sales grew.

China’s manufacturing purchasing managers’ index (PMI) for March came in at 51.8. A figure above 50 indicates expansion.

That beat market expectations, and was the highest in nearly five years. The non-manufacturing PMI came in at 55.1, the highest since May, 2014, with the construction sector leading the push.

This all points to a stabilising Chinese economy. The forecast hard landing is not panning out.

Not on these numbers.

That means support for commodities, and in turn our dollar. Though you wonder how much of that is already priced in. The Aussie dollar has already moved strongly in 2017.

Let’s bring up a chart. Here’s the weekly chart of the $US/$AUD:

usd aud
Source: STEX
Click to enlarge

For over a year it has simply traded a range, finding support at 71 cents and resistance around 78 cents.

The prospect of narrowing Aussie/US interest rate differential, the improving current account numbers, the state of the Chinese economy, all that is known and already in the price.

We just have to watch for a break of support or resistance for future news affecting the direction of our dollar.

Forgetting about US rate tightening, the prospect of a current account surplus and a AAA credit rating is likely to provide some support for the Australian dollar going forward. That’s only an opinion; should the dollar break previous support levels you have to put opinions aside and go with what the chart is telling you.

You may not know the reason for the break at the time; often the news comes out later to justify the move.

The levels of 71 and 78 cents give you the guideposts. Let the market guide you on where our currency is headed, rather than listen to opinions; mine included.

At Cycles, Trends and Forecasts we forecast a China slowdown, but we stressed that we didn’t expect a China collapse as many were forecasting. The latest figures look to be bearing that out. It was a good call in hindsight.

You can find out where the economy is headed next by going here.

Regards,

Terence Duffy,
Lead Researcher, Cycles, Trends & Forecasts

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Terence Duffy is an analyst and chartist, specialising in researching economic trends and cycles.  His primary focus is housing and land affordability. But you can also depend on him to offer his unique analysis of stock market charts. As Terence will show you, the charts often forecast, well in advance, the good or bad news to come.


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