The Fall of the Australian Dollar

Underperforming growth in China, improving economic conditions in the US, and the RBA’s recently announced cut in the cash rate to a record low of 2.75% have forced downward pressure on the Australian dollar – culminating in a loss of nearly 8% in value against the USD since mid-April. Crashing from its peak of $US1.10 in July 2011, the AUD has reached an 11 month low, with many analysts warning investors to brace themselves for further deterioration.

In the latest survey of economists conducted by the Wall Street Journal, forecasters expect US employers to add ‘180,000 jobs a month over the next 12 months’ to their nation’s economy with many expecting year-on-year economic growth to strengthen further. The monthly $US85 billion quantitative easing program (QE3) conducted by the Federal Reserve is expected to soften. Ben Bernanke, chairmen of the Fed, is set to testify before congress this Wednesday prior to the Fed’s next meeting next month that will end speculation regarding the future of the QE3 program. Economists and markets alike are predicting that this round of easing will come to an end in the near future. This economic optimism has resulted in investors diverting capital destined for Australian businesses and financial markets to the US, resulting in the USD rising not only against the Australian dollar, but also against all 16 of its major counterparts.

Declining commodity prices, due to a lacklustre Chinese economy, have also taken its toll on both Australian commodity exports and the dollar. China’s heavy reliance on our commodities to fuel their once seemingly insatiable growth has propelled them to the top of our largest export trading partner’s list. However, now that Chinese growth is floundering, the Australian economy has started to buckle. The reduced demand for our exports has led to a reduction in the demand for the AUD.

Japan’s implementation of ‘Abenomics’ earlier this year, particularly their audacious ¥7.5 trillion-per-month monetary easing program, has slowly begun to close the gap between the yields of long-term bonds in Japan and Australia. This has caused international investors, Japanese or otherwise, to seek alternative investments to achieve the same yield premium. Figures from Japan’s Ministry of Finance attest to this, with flow figures suggesting that Japanese investors are seeking better opportunities both domestically in Japan or abroad. The decline in capital inflow into Australian markets has weakened demand for the Australian dollar.

A fall in the target cash rate earlier this month, the Government’s newly unveiled budget that anticipates persisting deficits for the next few years, and an overall grim forecast for future economic growth are several domestic factors that have contributed to the eroding Australian dollar. Market sentiments toward Australia are becoming increasingly bearish.

In an attempt to stimulate spending, the RBA’s slashing of the target cash rate to a record low of 2.75% has deterred international capital inflow into our financial markets as investors seek higher returns in other nations. Likewise, domestic investors pursuing more attractive investment opportunities will be forced to do the same. Both independently and mutually, these two factors will result in a fall of the Australian dollar in comparison to our trading partners.

Budgeted deficits for the next few years, including an $AUD18 billion deficit for the forthcoming fiscal year, have further contributed to future domestic economic pessimism. In the hours following the budget announcement, the AUD/USD experienced roughly a 1-cent decline. Investors seeking to minimise risk have begun to opt away from Australian financial markets due to the potential risks posed by continual budget deficits. NAB chief economist, Alan Oster, predicts that the Australian economy will slow to an annual pace of 2%. Paul Brennan, chief economist of Citigroup Australia, reflects this sentiment of the domestic economy, asserting that none of Australian’s, “None of the Aussie’s key driver’s are positive.”

Indeed, the fall in the value of the AUD will produce both winners and losers. Overall, exports will become more attractive, while simultaneously, importing will become more expensive for domestic consumers and business.

Trade exposed businesses such as manufacturing and tourism are amongst some of the key industries that will seek to benefit the most. As the cost of purchasing the Australian currency lessens, the attractiveness of our exports increases. Conversely, businesses reliant on imports will experience unfavourable outcomes. As imports become more expensive, domestic consumers who have enjoyed purchasing internationally (through a medium such as the internet) will find this more expensive.

In the short-run, the dollar is highly unlikely to suffer a catastrophic fall, however, a gradual decline is expected for at least the next year. Goldman Sachs revised their year-end view of the Australian dollar, cutting its forecast from $USD0.98 to $USD0.90, citing a ‘fading’ recovery as ‘the investment boom peters out.’ Similarly, Barclays, has forecast a further slide of the dollar to $USD0.93.

In the past few years the AUD/USD exchange rate has dipped below equality with the greenback before spiking up again. Analysts and economists believe that this time, at least for the short to medium term, that the dollar will finally settle below parity.

References

1. Reserve Bank of Australia – Index of Commodity Prices 2013, ‘April 2013’, accessed 18 May.

2. Casselman, B & Izzo, P 2013, ‘Economic Road Clearing, but the Going Is Slow,’ Wall Street Journal, 12 May, accessed 18 May

3. Glynn, J 2013, ‘Australian dollar slides as market prepare for Fed stimulus tapering,’ The Australian, 17 May, accessed 18 May

4. All currency rates sourced from Yahoo! 7 Finance