Having concluded that most traditional alternative options are currently unsuitable, we suggest that investors add currency exposure to Portfolios, specifically long USD/AUD. We have been arguing for a weaker AUD since early 2012 when AUD/USD was still above parity, and finally seem to have entered the start of a period of USD strength and AUD weakness.
As we articulated in our recent Scoop (How Low can the Australian Dollar Go?, October 7, 2014) US Dollar strength could persist for several years owing to i) accelerating US growth, ii) rising relative US rates and iii) unsynchronised global monetary policy. At the same time the Australian dollar is likely to face downward pressure from lower commodity pricesand a sluggish domestic economy which will result in lower-for longer rates and potentially additional rate cuts.
Our currency model, driven by commodity prices, short term interest differentials and the cash rate estimates a fair value of 82.6c for the AUD (Figure 1). Higher US rates and a potentially lower cash rate in Australia will put further downward pressure on our fair-value estimate. Morgan Stanley’s FX Strategists recently downgraded their AUD/USD forecasts to 0.84 by end- 2014 and 0.76 by end-2015. Based on current spot prices the projected 12 month return on a long USD/AUD position is ~14%.
Certainly correct on the Australian side. But taper taper will weigh on the US side. More on that tonight.
Over the longer term a lower Australian dollar is inevitable, and much lower than 82 cents in my view by the end of the cycle. It remains a simple choice of pushing it down yourself or letting hollowing out do it for you over a longer time frame.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
