The Australian dollar’s 2017 surge appears to be at an end, with the currency falling in the past few weeks to dip below US75?? earlier this week.
But investors and analysts see little reason for alarm, with some short-term trader support for the currency keeping it from falling too far too fast.
The Australian dollar started the year at US72??, and surged above US77?? in the middle of March, capping off a period in which it was one of the world’s best-performing currencies.
But as of three weeks ago, it started to drop, falling below 75?? this week – its lowest level since January. It clawed back some lost ground on Tuesday to trade just above the US75?? mark.
On a trade-weighted index basis – where the Australian dollar is compared to a basket of currencies weighted by the volume of its trade relations with those countries – the Australian dollar rose rapidly for most of this year to hit a peak on March 15. It has since declined 1.9 per cent, giving up around half of its yearly gains. Steady interest rate disappoints
Chief economist of Colonial First State Global Asset Management Stephen Halmarick argues a shift in how markets were pricing the odds of a Reserve Bank of Australia interest rate hike has been behind the dollar’s decline.
“In early March, there was this kind of building up of expectation that the RBA was finished cutting interest rates, and if anything, the next move was gonna be up. The strength of the housing market was behind that view.
“And then, a few factors – particularly weak economic data releases – have reduced the expectations of rate hikes, and brought some discussion of rate cuts back into the equation. Our view hasn’t changed – which is that the RBA is on hold. But the balance of risks have shifted.”
After starting to price in the chance of a rate hike later this year, markets now see a 16 per cent chance the RBA will cut in December, pushing back the possibility of tightening to the first quarter of 2018.
“That’s weighed on the dollar – that’s the main thing,” Mr Halmarick said.
This narrowing interest rate differential is already playing out in some asset classes. The spread between US and Australian government bonds has narrowed, particularly on the shorter end of the yield curve. The yield spread between US-Australian two-year bonds has shrunk to 0.4 per cent – its narrowest level since the global financial crisis – making it relatively less attractive to hold the Australian-dollar dominated bonds.
Mr Halmarick, like others, does not expect a large shift from the dollar’s current valuation. “For the next six to 12 months, we see the Aussie dollar in the low US70s,” he said. PIMCO points to iron ore price
Robert Mead, the Australian portfolio management head of global bond investor PIMCO, views the dollar’s recent falls as an unwinding of its unduly elevated levels earlier in the year, which he attributed to the soaring iron ore price. Iron ore is now 20 per cent off its peaks in February, but hasn’t dragged the dollar down violently with it.
In Mr Mead’s view, the Aussie is “around fair value now”.
“From an investment perspective it means there’s no benefit to having active portfolio exposures to the Aussie dollar,” he said. It’s a relatively neutral positioning PIMCO is replicating around most currencies at the moment.
“The strength of the AUD between mid-January and mid-March looks to be the anomaly, rather than the weakness we have seen in the past few weeks.
“Iron ore prices were a major driver of the Australian dollar strength in Q1 and prices are now settling near the lows of the year. Iron ore inventories at Chinese ports are close to record highs and Chinese steel margins have been under some pressure which has contributed to recent downward momentum on the Australian dollar.”
In the short-term, support for the dollar could be discerned in recent price movements, said Greg McKenna, chief market strategist at foreign exchange provider AxiTrader.
He pointed out the dollar dipped below US75?? at several points early this week. But whenever this happened, it was quickly bid back above that threshold, suggesting some buyers were viewing any dip below this as a good buying opportunity.
He was also reluctant to offer strong indications as to where the Aussie will go in the future, saying it was “a difficult one to parse right now”. “I’ve been bullish and bearish this year, and it’s only four months in”.
Still, Mr McKenna believed the dollar was more likely to fall than rise, describing it as “incredibly vulnerable”.
“There’s been a turning in the key drivers of the currency,” he said. “There’s been a mini-collapse in the iron ore price. The Australia-US interest rate differential is falling. That’s two legs of what were previously strong underpinnings kicked out from under the table.”