USD trend key to AUD story – Westpac

Bill Evans, Chief Economist at Westpac points out that since the beginning of 2017, the Australian dollar has risen from USD0.72 to USD0.80 (11%) and commentators have tended to explain that move in the context of elevated commodity prices; growing expectations that an RBA rate hike will be delivered within twelve months and the booming employment market.

Key Quotes

“In fact, the dominant factor has been the reversal in the US dollar. This has been due to a material loss of confidence in the US economy. Most notably President Trump has failed to progress his reform agenda. Resurgent confidence in the European and Japanese economies have also been major factors in the reversal in fortunes of the USD (Canada and Mexico have also played a role).”

“Since the recent peak in the USD in late December 2016 (immediately following the Fed’s rate hike and the election of President Trump) the USD has depreciated by 11% against its DXY Index and the Euro and Yen have appreciated by 12% and 6% respectively against the USD.”

“Partly offsetting the tighter than expected stance of monetary policy in the US is market confidence that both the ECB (tapering purchases of securities) and BoJ (improving prospects for wages growth and inflation) will reduce policy stimulus over the course of 2018. Nevertheless, it is reasonable to conclude that relative to July 2016, the Fed has exceeded market expectations by more than the tightening expectations around the ECB or the BoJ.”

“Against the AUD/USD’s bilateral appreciation of 11% since 3 January, the RBA’s TWI has risen less than 5%. If we exclude the US dollar (and currencies pegged to USD), the gain is 3.5%. On both metrics, it is evident that the US dollar story has been responsible for the majority of the 2017 AUD move. There are good reasons to be optimistic about the USD going forward. A lift in confidence in the Administration is a reasonable proposition for the next 12-18 months. Tax reform is much more likely than health care reform. While the current developments around the relations between the Administration and the Democrats are clouded, there must still be bi-partisan support for some form of tax reform.”

“However, even if the Administration is successful in achieving some goals, the optimism which pervaded at the end of last year is unlikely to be replicated and we cannot expect a full unwinding of the USD negativity that we currently observe.”

“Based on the discussion above, an increase in the USD out to end 2018 of 5-8% is reasonable. To supplement our expectation that AUD can drift back to USD0.70 (12% depreciation in all) we are also of the view that non USD factors will weigh on the AUD (RBA on hold and a slowdown in China pushing down commodity prices by 15-20% in 2018).”