AUD - Parity beckons

Tue, 25 Feb 2014  |  

It seems most of the market has missed it, but the Australian dollar has already had its sell-off, dropping from 110 US cents in July 2011 to 86.60 cents just last month. The peak to trough fall is over 20%.

Down at around 87 or 88 cents was the time to get in because the pick up, back to around 90 cents at the moment, is just the start of trend that should see the AUD move back to 95 cents and then above parity.

With any good fortune Australia's way, a retest of the 110 high is possible in the next 24 months.

The drivers of the Aussie dollar are best summed up as commodity prices, the trade balance, interest rate differentials, risk via Australia's sovereign credit rating, global growth and cross border investment flows. There are others, but they are generally of low importance.

Most of these drivers are either neutral or positive towards the AUD.

• Commodity prices are flat to up. The RBA's own index of commodity prices in USD terms is down just 0.3% since July 2013. The broader CRB index, which is a better proxy for global activity and inflation pressures, is up 10% from the January low and is at its highest level since February 2013.

• Australia's international trade balance on goods and services has turned from monthly deficits around $2 to $3 billion in late 2012 and early 2013 to surpluses in the last two months. This suggests, at the very least, the AUD around 90 cents is giving a huge boost to the traded part of the economy.

• The interest rate differential between Australia and the US is edging out, notwithstanding the Fed's policy resolve to taper its bond buying program towards zero. In Australia, the flood of positive economic news and higher inflation has seen the market swing from pricing in a cash rate near 2.0% to now be pricing in rate hikes in the next year or two.

• In terms of risk, there is no material threat to Australia's triple-A credit rating. The fiscal position is in tip top shape and when Treasurer Hockey delivers the budget in May, a move to budget surplus will only reinforce the rolled-gold fiscal settings that have been evident in Australia for the last few decades. Australia will remain a shining light for global investors because of the triple-A status.

• It terms of global growth, which admittedly is a proxy for commodity prices and risks, the news is good. It seems the recovery in the world economy is rolling along and while I admit to being somewhat cynical about the deliverables from the G20 Finance Minister's meeting, if there is any bias to stronger growth that comes from the world economy over the next year or two, Australia, and the AUD, will be caught up in the flurry.

All of which suggests the AUD will be biased higher over the next year or two. If we get unexpected strength in the global economy and the RBA acts to hike interest rates earlier than the market is thinking, a powerful move is more likely than not.

For what its worth, the AUD is likely to be above 95 cents towards the end of 2014 and in a 100 to 105 range by the middle of 2015.

 

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