Why the Aussie Dollar Won’t Fall Below $0.70 This Year

Westpac, one of the big four banks, predicts the Aussie dollar could fall below $0.70 this year. It’s hard to get away from the sense that this assumption is built on a false premise.

Granted, Westpac admits that a number of events would have to transpire for this to happen. Some of these, like a mass flight to safe-haven assets, are not only possible, but probable. But they’ve gotten it wrong on the matter that counts most. What’s that?

One of the key planks in Westpac’s future valuation of the AUD relates to US interest rates.

Like most mainstream economists, Westpac believes the US Federal Reserve will raise rates this year. It predicts the Fed will act twice this year, lifting rates by a combined 0.50% up to December.

But this blind assertion that the US will tighten credit this year is both inaccurate and misleading. Westpac’s theory on US rate policy predictably follows the same mistakes too many economists make.

Nothing the Federal Reserve Chair Janet Yellen says to the contrary makes any difference. She’s paid to misdirect the markets.

Yellen’s been dropping hints that rates could rise this year, provided the economy meets her expectations. In other words, if the economy improves, rates might go up. That’s a big ‘if’.

The US is in no position to raise rates in its current state. Economic data suggests US growth is sluggish, and worsening. The World Bank recently lowered its forecast for US growth to 2.7%. That was revised down from its 3.2% forecast in January.

The fact that growth is slowing is hardly a ringing endorsement for a rate hikes.

What’s more, unless inflation picks up the Fed has little reason to tighten credit. The Fed is on record as saying that both inflation and labour markets will need to improve before they consider tightening credit.

Core inflation would need to increase to 2%. At 1.8%, inflation is still comfortably below the Fed’s internal target. Inflation numbers are actually the reason why economists are so hung up about the jobs market. With Yellen raising prospects for a rate rise, everyone is looking at the unemployment rate for signals.

US employment: where are all the jobs?

If you believe official figures, the US jobs market is trending positively. At 5.5%, the unemployment rate is lower even than Australia’s. That’s pretty good, or so economists think. But things aren’t as rosy as they might appear.

For one, the growing trend of people abandoning the workforce shows no sign of slowing. More and more Americans have ceased looking for work, full-stop. Officially, they’re part of America’s ‘improving’ jobless rate. Unofficially, they’re merely disguising a weak labour market.

Another negative long-term trend is the so-called ‘job finding rate’. This refers to the likelihood that an unemployed person will find a job in any given month. This job finding rate is growing at a slower rate than it did last year. That supports figures showing the number of people giving up looking for work is on the rise. If people aren’t likely to find work, they’ll be inclined to stop searching altogether.

But if that’s not enough evidence, then what are we to make of wage growth data? If unemployment was improving, we’d see it reflected in higher wage growth. More people looking for a limited number of jobs should push up wages, in theory. But that’s not what’s happening — far from it. The average hourly pay of the average US worker grew by a measly US$0.03 in the year to March.

All in all, the validity of official data is questionable, at best. There’s good reason to believe that the situation is much worse than the numbers indicate.

Is the Fed ready to upset the global economy?

The health of the global economy is another factor weighing on the Fed’s rate policy. Any further rise in the value of the greenback will hurt growth prospects among emerging economies. The International Monetary Fund actually referred to this very concern in a recent statement on the Fed’s rate policy.

You might be asking: why does this matter to the US economy?

It matters to the US because it hurts America’s potential growth as well. American exports, and investments across key sectors, would decrease if the global economy shrinks further.

One way or another, the US can’t get away from global problems. It’s true that the US is probably the one economy that could manage a global downturn better than anyone else. But that’s beside the point.

A slowdown in global growth will temper any potential US recovery. And that would defeat the purpose of raising rates in the first place, after all.

The problem is that the prospects for the global economy are getting worse, not better. The world is facing the likelihood that GDP growth will remain sluggish for the next several years. The global economy could once rely on emerging economies to offset sluggish growth in the developed world. That’s not the case anymore.

China serves as an example for everyone

China is only the  most prominent example of slowing global growth. Their toils are a warning sign to anyone that still retains optimism for the future ahead.

China just scraped over the line in meeting its 7% growth target for the year. At least, that’s what the Chinese government would have you believe. Remember, this is an economy renowned for its top-down management. Sometimes, you have to bend the rules to make a point. And the Chinese are keen to make a point that they’re doing fine, all things considered.

But it’s hard to swallow official statistics at face value.

The reliability of their economic data leaves a lot to be desired. Even if we took their word for it, there’s no question that China is rebalancing. It’s slowly transitioning from an export driven economy to one built on consumption. It’s taking a few hits in the process, as growth inevitably slows. But whether this transition is managed to provide a soft landing for the economy is anyone’s guess.

What we do know is that managing China’s slowdown is a global concern. As its economy stagnates further, China’s demand for resources will decline as well. That’s a big deal if you happen to be a major, resource-exporting nation.

Take Russia as an example.

US consumers, like any others, like low oil prices. In fact low oil prices can spill over into the broader economy. The lower the cost of energy, the more that people have to spend on other goods.

But lower oil prices hurt exporters like Russia, not to mention oil producers in the Middle East. As their main source of income, it makes raising global growth a bigger challenge.

What do China, Russia and the Middle East have to do with the US? Well, the fortunes of the Chinese economy dictate those of the world too. If China drags on other emerging economies, then it’ll come back around to the US eventually.

If the entire world is slowing down, then the US will too.

Where to next for the Aussie dollar?

For seven years now, the Fed has kept interest rates at near zero. That’s not going to change by the end of this year, for the reasons outlined above.

All this brings us back to the question of the Aussie dollar. Without a US rate rise, the AUD is likely to remain above $0.70 this year.

The Reserve Bank of Australia has proven its rate cuts only have marginal effects on the Aussie dollar. Commodity prices, which could still fall further, will have a negative effect on the dollar. But it’s hard to see commodity prices alone sending the AUD below $0.70.

That means it’ll be the Fed who has the final say on the Australian dollar. They just won’t be saying much this year.

Mat Spasic,

Contributor, Markets and Money

PS: Markets and Money’s Greg Canavan believes the Aussie economy is heading for disaster. He says any further interest rate cuts will fail to prevent a near certain economic decline. Not even the hope for a weaker dollar — and export driven rebound — will be enough to change this. In fact, as one of Australia’s leading investment analysts, Greg is convinced that Australia faces a recession in 2015.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why our economy finds itself in the hole it’s in. He’ll show you why our economic conditions have spiralled out of control — and why that means a recession is almost inevitable.

But Greg also wants to show you a way to protect your wealth. He believes there are steps you can take right now to protect yourself from the fallout of the imminent recession. To find out how to download his free report right now, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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