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Australian Dollar to Bounce Back Next Year; Investors Sense Buying Opportunity

As investors begin playing the long game, they are reconsidering their views on the Australian dollar. An inevitable tightening of Australian monetary policy, most likely next year, will eliminate one of the chief reasons for recent AUD pessimism. What was once a currency worth avoiding might now offer a heavily-discounted bargain.

The Australian dollar is in recovery mode. On September 11th, it slumped to a nineteen-month low of just 70.85 US cents. Since then, eleven days of gains from the past twelve has brought the Aussie back to the mid-72s, to the relief of many. While it remains a long way down on January’s highs (it’s still 11 percent lower versus the US dollar) it perhaps offers an attractive buying opportunity for those strategically inclined and in it for the long run.

When all is said and done, the dominant drivers of foreign exchange markets are interest rates, and one reason to swerve the Australian dollar of late has been the evaporation of Australia’s interest rate advantage.

While the Reserve Bank of Australia upholds interest rates at 1.5 percent, where they’ve been since mid-2016, the US Federal Reserve has gradually increased its rates to 2 percent, with more increases expected. With more being paid on US currency deposits, the market is offering a great disincentive to hold Australian dollars. As “hot money” is exchanged into US dollars for the purpose of earning interest, Australian dollars are sold, driving down their price.

To put things into perspective, consider that between 2008 and 2012 central bank rates in Australia averaged 5 percent and, by comparison, for much of that time equivalent rates in the US were at a miserly 0.25 percent.

AUD to USD - 3 month chart - Latest
AUD/USD - 3 month Chart - Latest

While it’s questionable whether Australia will again enjoy a 4-percent or higher rate premium relative to the US (that would be unthinkable for the next decade at least), what isn’t in doubt is that Australian rates will be increased from current record-low levels; it’s a question of when, not if. Any action at all taken by the RBA to improve interest rate differentials will be of substantial benefit to the Australian dollar’s valuation.

Higher interest rates can, of course, be enacted only at a time when the Australian economy and consumers can bear them, and that’s a judgement to be made by the economics boffs at the RBA. Based on current market expectations, the first of several 25-basis-point hikes is expected in Australia in late 2019, but that doesn’t mean the Australian dollar can’t rally before then. An important and currently unanswerable question related to this is how far towards the end of its own rate-hiking cycle will the Federal Reserve be at the time the RBA takes action?

This longer-term consideration of relative monetary policies is the reason why “high net worth investors are betting on a rebound in the Australian dollar,” reports the Australian Financial Review. Investors have “swooped on weakness in the currency to lift purchases of the Aussie . . . to their highest levels since 2016.”

According to the AFR, Citibank is of the opinion that investors are smartening up and are now willing to turn a blind eye to short-term AUD volatility or weakness in order to get in while the currency is cheap.

Although a good number of institutional forecasters expect to see a retest of recent lows in the near term, the 2019 outlook for the Australian dollar is improving.

Until recently, Citibank itself had been showing a twelve-month AUD/USD forecast of 69 cents. Per the AFR, experts at the bank are changing tune.

“When the RBA does raise rates, the difference between the Aussie and US rates will narrow. Long term we are bullish on the Aussie. We’re forecasting US77¢ for the next 12 months and beyond,” says Citi’s Mahjabeen Zaman.

As for 2018, with the fourth quarter fast approaching, analysts at the “big four” Australian banks have been busy revising end-of-year forecasts. In early September, AUD forecasts from NAB, Westpac, ANZ and CBA averaged 72.5 US cents, indicating no change on current levels.

Please note that the opinions of our authors are their own and do not reflect the opinion of Best Exchange Rates and should not be taken as a reference to buy or sell any financial product.

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