Fx watch aud weakness to continue may 2016

FX Watch

Group Economics Macro & Financial Markets Research

16 May 2016

AUD weakness to continue?

Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com

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Limited AUD downside as financial markets have priced in rate cuts…

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… we expect AUD to firm though strength likely to be limited…

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…as RBA would step up easing in case of strong AUD bounce

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New year end AUD/USD forecast: 0.74 in 2016; 0.75 in 2017

Limited AUD downside as financial markets have priced in rate cuts We think there is limited room for further Australian dollar (AUD) weakness and expect the currency to find some support above 0.70 versus the dollar this year. In our view, the Reserve Bank of Australia (RBA) is likely to cut the Official Cash Rate (OCR) by 25bp to 1.5% later this year in August. However, this is almost fully priced in. A back to back rate cut next month in June is unlikely unless there is a new ‘shock’; either in the form of large divergence between the AUD and commodity prices and/or economic growth in the first quarter (to be published on 1 June) is much weaker than the RBA’s GDP forecast of 2.53.5% for 2016. As a result, the AUD may recover to around 0.73 (previous forecast 0.76) as financial markets are pricing in about 25% probability of 25bp rate cut at the next monetary policy meeting on 7 June. However we expect any gains in the AUD to prove temporary as the RBA is likely to maintain a dovish stance. In addition there is room for further liquidation of net long AUD speculators’ positions given the RBA’s monetary easing bias. Hence the AUD is likely to ease lower to around 0.72 (previous forecast 0.76) in the third quarter.

Monetary policy expectations in Australia

Non commercial AUD futures positions

%

Number of contracts

2.00

150000 100000

1.50

50000 1.00

0 -50000

0.50

-100000 Jan-11

0.00 Jun-16

Aug-16 ABN

Oct-16

Dec-16

Jul-13

Oct-14

CFTC non-commerical long AUD futures positions

Cash rate futures implied OCR

Source: Bloomberg, ABN AMRO

Apr-12

CFTC net non-commerical AUD futures positions Source: CFTC

Insights.abnamro.nl/en

Jan-16

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FX Watch – AUD weakness to continue? 16 May 2016

Looking further forward, a recovery in the AUD back to 0.74 (previous forecast 0.76) is expected at the end of this year for several reasons. Financial markets have priced in that the OCR may be as low as 1.4% by the end of this year compared to our view of 1.5%.

We also expect the Fed to keep monetary policy unchanged this year which is less optimistic than what is priced in by Fed funds futures. Our base case scenario is that the RBA keeps the OCR unchanged at 1.5% throughout 2016 and 2017. This is based on the view that economic growth is likely to improve from 2.5-3.5% in 2016/17 and to 3-4% in 2018. Given the RBA’s projection that the unemployment rate is expected to decline in the second half of 2017, a tighter labour market should eventually support wage growth and non-tradable inflation.

Downgrade AUD forecasts: RBA monetary policy sensitive to exchange rate The strength of the AUD upswing will be contained as the RBA would step up monetary easing in case of a strong AUD bounce, which would undermine the currency again. This would especially be the case if the AUD is much stronger than implied by Australia’s key commodity export prices. This behaviour was evident during late 2013 to the middle of 2014 when the RBA lowered the OCR to levels below inflation rate (Trimmed mean). As shown in the graph below, during this period the AUD was trading at much stronger levels than justified by Australia’s key commodity export prices. A stronger AUD than projected by the RBA (AUD TWI: 62.5; AUD/USD 0.75) will weigh on services exports which is highly sensitive to movements in the exchange rate and tradable inflation. The RBA is unlikely to tighten monetary policy next year given that underlying inflation is projected to remain below the RBA 2-3% target range well into the middle of 2018. We expect the AUD to trade around 0.75 (previous forecast 0.80) over the course of 2017 given that financial markets have priced in our view that monetary policy in Australia will remain unchanged and the Fed will raise interest rates by 75bp in 2017.

AUD/USD; Australia’s key commodity export prices Level

ABN AMRO major currency forecasts

Index level

1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 Jan-10

160 150 140 130 120 110 100 90 80 Apr-11

AUD/USD (lhs) Source: RBA, Bloomberg

Jul-12

Oct-13

Jan-15

Apr-16

RBA commodity price index (rhs)

EUR/USD USD/JPY EUR/JPY GBP/USD EUR/GBP USD/CHF EUR/CHF AUD/USD NZD/USD USD/CAD EUR/SEK EUR/NOK

16-May 1.1318 108.74 123.08 1.4367 0.7878 0.9756 1.1042 0.7295 0.6786 1.2912 9.3188 9.2525

Source: ABN AMRO

Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 1.15 1.15 1.15 1.15 1.15 1.15 1.15 105 108 110 110 110 108 105 121 124 127 127 127 124 121 1.40 1.42 1.48 1.50 1.52 1.54 1.56 0.82 0.81 0.78 0.77 0.76 0.75 0.74 0.96 0.96 0.96 0.97 0.97 0.98 0.99 1.10 1.10 1.10 1.11 1.12 1.13 1.14 0.73 0.72 0.74 0.75 0.75 0.75 0.75 0.68 0.68 0.68 0.69 0.70 0.71 0.72 1.25 1.22 1.20 1.18 1.17 1.16 1.15 9.25 9.25 9.25 9.25 9.00 9.00 8.75 9.25 9.00 8.75 8.50 8.50 8.25 8.25

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FX Watch – AUD weakness to continue? 16 May 2016

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