The Australian dollar appears to be resuming its rising trend and the AMP’s chief economist, Dr Shane Oliver says investors and business have to be prepared for the changes that will bring.
We have already seen the pressures the rising dollar brings (and the benefits) from 2008 and from the past six months.
Now he says the dollar will test parity with the greenback sometime this year.
It seems whenever economists start talking about parity for the $A against the $US, the $A loses puff and heads lower.
But right now it seems to be heading in the direction of parity again, and despite the chips having gone stale and the champagne flat from the last aborted parity party, we remain of the view it will get there sometime this year.
While the $US outlook is no longer the clear positive for the $A that it was last year, a widening interest differential in Australia’s favour, strong commodity prices and favourable perceptions of Australia’s economic fundamentals certainly are.
$US picture is mixed, but doesn’t preclude $A strength
Through much of the last decade the $US has been in a broad downtrend and this made it easier for the Australian dollar to push higher.
However, since late last year there have been increasing signs the $US may have bottomed against major currencies.
While the $US is still beset by an excessive level of both private and public debt and needs a lower currency if it is to rebalance its economy in favour of higher exports, Europe and Japan are arguably in worse shape.
In terms of Europe, the fiscal crisis in southern European countries and the associated negative impact on economic growth in the region is likely to ensure the European Central Bank will have to maintain easy monetary policies longer than the US Federal Reserve.
This augurs poorly for the Euro over the next year or so.
Similarly, ongoing deflation will maintain pressure on the Bank of Japan to retain easy money much longer than the Fed, which augurs poorly for the Yen.
Against this, the likely resumption of Chinese Renminbi appreciation in the near term and tightening monetary conditions in many emerging countries point to downwards pressure on the $US against emerging market currencies.
Similarly, commodity currencies are being supported by earlier moves to monetary tightening and strong commodity prices. In this context it is worth noting the strength in oil prices amongst other things has pushed the Canadian dollar above parity against the $US.
The point is, whereas the $US may have reached some sort of bottom against the Yen and the Euro, it doesn’t preclude further strength in the $A.
In this regard it is noteworthy the $A has held up well against the $US since late last year – essentially going sideways – despite the Euro falling around 12% in value against the $US.
Essentially there are three major factors pushing the $A up: strong commodity prices, a widening interest differential and strong economic fundamentals.
Commodity prices are strong and likely to trend higher
The trend in commodity prices is likely to remain up as Chinese economic growth remains strong, the US housing cycle bottoms, infrastructure spending globally remains high, all at a time when commodity supply remains constrained.
Our view remains that commodity prices have now embarked on another cyclical upswing in the context of a long term bull market, or super cycle. See the chart below.
This is positive for the $A as commodities make up 60 to 70% of Australia’s exports.
The interest rate differential in Australia’s favour is likely to widen further
Australian official interest rates currently at 4.25% are well above those in the US, Europe and Japan where the range is zero to 1%.
What’s more, the Reserve Bank of Australia is continuing to signal more rate hikes ahead.
However the message from the Fed is rate hikes are still some time away and rate hikes in Europe and Japan are still over the horizon.
As a result, the interest rate differential in favour of Australia is set to widen.
By year end the short term interest rate differential is likely to have increased to 4.25% versus the US, 4% versus Europe and 4.75% versus Japan.
Strong economic fundamentals
The global financial crisis (GFC) has likely dramatically improved investor perceptions of Australia.
It is the only OECD country not to have succumbed to recession through the GFC; it has zero net public debt; it is seen as well managed; and a relatively safe way to invest in the strong China story.
This favourable shift in perceptions is likely adding to long term upwards pressure on the $A.
So how far can the $A go?
During the post float period since 1983 the general perception was that fair value for the $A was around $US0.70 and most fair value models for the $A constructed over this period confirmed this (as would be expected).
However, it’s likely this relatively narrow period of history misses the longer term perspective and the changed reality facing Australia.
Back in 1901 the equivalent of one Australian dollar bought $US2.40 and for most of the last century the $A was above parity against the $US.
The long term s
