Why Goldman Sachs is Wrong About a US$0.75 Aussie Dollar

When the Aussie dollar hit a six year low this month, it wasn’t enough for some. At US$0.68 to a US dollar, the Aussie has fallen 20% against the greenback this past year. And it appeared as if the dollar was yet to find its floor. Especially with commodity prices continuing their two year long slump.

This price collapse has wrought havoc with commodity currencies in the past few months in particular. Slowing emerging market growth, coupled with weak prices, has dragged on commodity exporting currencies.

In any normal circumstance, a weaker currency is bad for business. It implies dwindling purchasing power. Every dollar buys you less than it once did. But we’re not living in normal times — that much is clear by now.

Every economy is hell bent on exporting its way to growth. You can thank policymakers for this. They’re the ones putting all their eggs in the currency basket. How?

Well, a weaker dollar is the Reserve Bank’s only strategy for stimulating economic growth. And not just because a cheaper dollar boosts exports. The RBA is relying on a weak Aussie to perk up other sectors, like tourism.

Since July, the dollar shaved $0.07 from US$0.75. So far so good, then. Market analysts were queuing up, predicting a US$0.60 floor for the Aussie dollar.

So it’s somewhat of a surprise then that there’s anyone still bullish on the Aussie. And it’s a credible source too…

Goldman Sachs is betting on an Aussie dollar rebound. It sees the dollar recovering most of its losses since July. Its reason? Because it thinks fears over the global economy are fading. And it puts this down to two things in particular.

For one, it says that market concerns about China’s slowdown are easing.

On top of this, it believes commodity currencies will gain from a lack of movement in US interest rates.

Last week, the US Federal Reserve held interest rates at near zero. Markets were expecting a marginal increase that never came.

Ultimately, the uncertainty over the global economy weighed on the Fed’s decision. Now there’s no telling when the Fed’s rate ‘lift off’ will begin. The likelihood of a rate rise in 2015 has shrunk. Futures markets forecast less than a 50% of a rate hike this year.

Either way, these factors are influencing the Aussie dollar. And they’ll continue to for the foreseeable future. So much so that Goldman thinks the Aussie may rise back to US$0.75.

That would come as a blow to the RBA. It would undo all its efforts to lower the dollar these past few months.

But I’m not convinced Goldman have this right.

For one, I don’t think the RBA is finished with rate cuts this year. I still expect interest rates to fall to 1.75% by November. I don’t think it will have any choice once the Q3 GDP data is out. The economy isn’t likely to grow at much more than the 0.3% it did in Q2. That would put us on course for growth of less than 2% this year. Which is something the RBA won’t allow.

At the same time, China’s weak growth will continue weighing on the Aussie dollar. Goldman’s verdict on China, as I’ll explain, might be overly optimistic.

Goldman remains bullish on China

China stimulates a lot of debate on markets, and rightly so.

The Shanghai Composite has shed 29% off its market value since June 30 alone. Pin the blame on short sellers or panic stricken retail investors. It doesn’t matter. Whatever the reason, the selloffs lead back to one thing: China’s growth. Or, rather, its lack of growth. The entire world is freaking out over China’s ability to hit a 7% growth target.

Even worse, we’re talking about a measly 0.2% difference.

Early estimates for this year pen the Chinese economy growing at closer to 6.8%. It doesn’t sound like much of a difference, but global markets work on the fringes. Anything below 7% is a sign of apocalypse. For no other reason than that it’s an arbitrary number set by Chinese officials. Nor does it matter that 6.8% is wild growth by global standards…

You can debate the logic of this all day, but it’s how things operate.

Whichever way you look at it, the world’s second largest economy is a lynchpin in global trade. It imports a wide array of minerals from major commodity exporters. That props up a number of emerging market economies, such as Brazil. But it also underpins prosperity in richer economies in Australia and Canada.

What worries many is not so much China’s slowing economy taken in isolation. Instead it’s what this spells for the rest of the world that’s causing panic across markets.

Yet Goldman isn’t reaching for the exit just yet.

The bank believes China is managing its slowdown effectively. Goldman says Chinese policymakers are keeping the situation under control. And, while it concedes the economy is slowing, it sees plenty of upside too. Goldman notes:

We identify a slowdown for sure, but it’s not a massive slowdown. The Chinese economy is weakening, but it’s not weakening across the board, and there are actually some parts of it that are actually doing quite well.’

What parts? Consumer driven ones for the most part. The bank sees retail and property in particular as signs of an emerging recovery.

What does this all have to do with the Aussie dollar?

If confidence in China’s economy picks up, then the Aussie will gain ground. It has no choice but to. The health of China’s economy dictates the fortunes of commodity currencies.

Of course, China’s ‘revival’ is not guaranteed. It’s early days yet. We won’t know whether China’s economy is on course for any longer term recovery.

After all, we know that Chinese policymakers are intent on shifting the economy towards consumerism. And we know that slowing growth typically accompanies such monumental shifts.

But it probably won’t be enough. Just look our own situation.

Here in Australia, we talk of a hypothetical non-mining recovery. Led by what? Tourism and education? Rising consumption? These are the usual answers trotted out.

As great as all this would be, it’s nowhere near enough. Not enough to offset the decline in commodity revenues. Which explains why Australia’s growth rate plunged to just 0.3% in the second quarter to June.

The same thing is happening in China.

People want to believe that consumers can offset China’s slumping trade, which fell 8.3% year on year. That it can make up for plunging factory output, which has fallen seven straight months. That these economic indicators are down despite aggressive monetary easing on the part of Chinese policymakers.

I wouldn’t bet on it.

Retail  propped up by easy credit aside, China’s economy isn’t showing concrete improvement.

Until it does, commodity currencies will flatten and decline. Yesterday’s massive selloffs across the Aussie mining sector should tell you as much.

Where’s the Aussie dollar heading?

Because of this, you shouldn’t expect the Aussie to trade higher than US$0.72 again this year. I still see it finishing the year closer to US$0.65. But it will probably trade in a band between US$0.67–0.70.

But to hit that low, a few things needs to happen, all of which I believe are lock ins.

For one, US rates will have remained steady at 0.25%. Rising interest rates will actually help the Aussie dollar weaken. But I don’t see any movement on this until next year. At least not until the outlook for the global economy clears up.

Two, commodity prices won’t have seen any rebound. If anything, they’ll trend lower from present levels. Market share strategies, which increases global supply levels, aren’t going away.

And finally, the RBA will have to cut rates again, by at least 0.25%. Again, this will depend on how badly the economy fared in Q3. If it does slash rates, then US$0.65 is a real likelihood this year. Especially if it’s combined with the two factors I mentioned above.

The Aussie is trading at a middle ground of US$0.70 this morning. If Goldman is right about a US$0.75 dollar, the global economy will be improving by the end of the year. If it’s wrong, you’ll know exactly how bad things are getting.

Mat Spasic,

Contributor, Markets and Money

PS: In its September meeting, the Reserve Bank decided to hold interest rates at historic 2% lows. According to Markets and Money’s Phillip J. Anderson, interest rates will remain low for a long time yet.

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But there is another way. Phil’s eager to show you the best way to invest in this low interest rate environment. He’s prepared a four-step strategy that could boost your wealth. You’ll learn where to park your cash over the coming decades. And you’ll see how this could lead to immeasurable profits… To download the report, click here.

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