Why the Aussie Dollar ‘Prophet’ Could Be Wrong This Time

Konrad Bialas knows a thing or two about the Aussie dollar. In fact, no one knows the currency better than him. Bloomberg ranked Bialas, a forex strategist at TMS Brokers, as the most accurate currency analyst this past year. So when Bialas says the Aussie will end the year at US$0.69, you can’t help but sit up and take notice.

Yet there’s a chance he’s wrong on this one.

It’s hard arguing with someone holding a track record like Bialas. But he bases his forecast on some questionable grounds.

Bialas’ prediction revolves around the idea that US interest rates are heading up. As early as December of this year, even. Yet there’s no guarantee of that happening.

If you’ve been following the situation, you’ll know why that is. Concerns over global growth and worries about low inflation in the US remain. There’s enough doubt to keep the Fed at arm’s length from changing its interest rate policy. And if neither situation tilts in favour of rate hikes, the Fed’s not likely to pull the trigger. That’s a simplification of the situation, but it’s not far from covering the whole truth.

But let’s pull things back for a moment. Cast your eyes on the Aussie dollar’s recent swings.

As it stands, the Aussie dollar is on somewhat of a tear. Its rallied in recent weeks, climbing to US$0.73 against the greenback. It even hit a seven week high last Friday, nudging US$0.735. This was mostly down to US rates remaining unchanged.

The issue of US rates leads most currency market swings today. It’s even more important than slowing emerging market growth. Not least because commodity currencies are praying US rates start climbing soon. As you know, rising rates would boost the US dollar, putting pressure on commodity currencies in turn.

But now that expectations for US monetary policy changes are dying down, the Aussie dollar is climbing.

Yet Bialas reckons these gains won’t last the rest of the year. He sees the Aussie falling back below US$0.70.

What’s interesting about this forecast is not that he expects a weaker Aussie dollar. Instead, it’s what he says about the dollar’s floor that’s intriguing.

Bialas can’t see the dollar dropping below US$0.69 this year. In fact, he doesn’t see it falling below that threshold in 2016 either. He reckons the Aussie dollar has lost as much value as it will. And maybe he’s right…

The dollar’s plunged by 20% in the year to September. It even reached a low of US$68.96 on September 7. But Bialas reckons the current high won’t last. In his view, US rate hikes, starting in December, will weaken the Aussie dollar.

But is that true? I’ve touched on what’s preventing the Fed from hiking. So what’s pulling them in the opposite direction? And what makes Bialas so sure of this?

Bialas actually has an interesting take on this. And not one you hear often from economists elsewhere.

He pays particular attention to the rally taking place on markets right now. The recent surge in stocks and commodity currencies, he says, may ease worries the Fed has about lifting rates. It’s a roundabout way of thinking, but it does have some merit.

Yet it’s also a very optimistic way of looking at things.

We know the Fed is mindful about not adding any further stress on the global economy. Which is exactly what rising interest rates would do. The levers of easy credit would tighten, lowering any likelihood of boosting global growth. It’s unlikely the situation facing the global economy will change by December.

The other factor playing into Bialas’ argument is that commodity currencies continue edging higher. That’s what Bialas is betting on. He reckons that will leave the Fed with room to lift rates.

Should this happen, the Aussie dollar will take a major hit. One that would see it plunge below US$0.70 again. Here’s Bialas speaking on this, from the AFR:

The markets “are raising chances for December lift-off” and when that begins to [reflect] in statements from the Fed and its policymakers “it will be devastating for current sentiment’.

But there’s no guarantee Bialas is right about this.

I’ve maintained for months that US rates would remain unchanged until mid-2016. When the Fed held rates steady last month, it admitted as much. It was an acknowledgment that rates could remain at 0.25% for a while yet.

Many economists now think any change before 2016 is unlikely. It’s not hard seeing why market sentiment changed so fast either. Global economic conditions aren’t likely to improve much in the next eight months. Neither is US inflation, which remains below a target of 2% at 0.2%. Those two factors together could constrain the Fed’s policymaking in the medium term.

Where the Aussie dollar goes from here

As for the dollar, Bialas sees it bottoming out at US$0.68 in Q2 2016. At that point, market sentiment will turn towards looming Aussie rate hikes. If Bialas is right about a December US rate lift off, he doesn’t see the RBA changing Aussie rates until Q4 2016. By that point, he says the RBA will follow in the Fed’s footsteps. He reckons Aussie rates will edge up by 0.25%, to 2.25%.

That, along with an improving outlook for commodities, could drive up the Aussie dollar. By December 2016, Bialas sees the dollar hitting US$0.71.

Yet coal, oil and iron ore prices are all down, which makes any recovery in 2016 optimistic. Goldman Sachs forecast iron ore prices hitting US$40 a tonne by 2019. Just last week, it predicted oil prices could stay low for another 15 years too. Neither of which would help any rebound in commodity prices.

So why the bullishness over commodities then? Bialas reasons:

Right now we’re most focused on China’s growth and commodity price prospects. The bulk of adjustments to structurally lower Chinese demand growth for industrial commodities will take place at the turn of the year. [In the second half of 2016 expectations] for higher demand in 2017 will lift commodity prices’.

Whether those expectations prove accurate is another matter altogether. Higher demand for construction isn’t guaranteed. John Minnich, a Stratfor analyst, perfectly summed up the state of Chinese construction recently.  Here’s a passage worth reading over (emphasis mine):

I think it’s highly unlikely that we would see anything even approaching a return to the kind of massive growth, massive rises in home prices and massive growth in real estate-related investment that we saw over the course of the last six years.

First and foremost, like I said, we’re coming off of a period of such intense construction and the oversupply at this point is so significant that to see yet another period of comparable growth in investment and construction, I mean it would defy not only all economic logic, but also the Communist Party’s policy priorities.

‘I mean we’re at the point now where the idea now going forward is for the government to begin or to continue the process of urbanizing the interior and to begin to create the conditions so that we have new classes of incoming urban residents who can begin to metabolize that existing housing oversupply rather than developing even more oversupply on top of it’.

The likelihood of another construction boom in China next year is optimistic at best. China isn’t ripe for that. It first needs to fix its problem with oversupply.

In fact, everything suggests China’s set for a sustained decline over the next few years. Trade terms are down, and manufacturing is falling. In August, slowing Chinese factory output was responsible for the Aussie dollar falling to $0.69.

The Chinese government will do all it can to soften these blows. You’ll likely see further rate cuts, possibly falling below 4% by 2017. All in a bid to stave off the effects of slowing growth, which could dip to 6.5% this year alone. With that, commodity currencies will continue their slide too.

So that’s what’s in store for the Aussie dollar. If you believe Bialas about US rates and rising commodity demand, the dollar will edge lower before settling around US$0.71 by 2017.

But you might take the opposite view, as I do. The emerging market slowdown, led by China, shows few signs of recovering in time for next year. Because of this, US interest rates won’t move until at least mid-2016. Which would make keeping the Aussie dollar above US$0.65 next year something of a miracle.

Mat Spasic,

Contributor, Markets and Money

PS: The Reserve Bank held interest rates at record lows of 2% when it met last week. But as long as the US Fed maintains near zero rates, the pressure will be on the RBA to cut again soon.

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