So how much further can AUD/USD go? In our FX Roadmap for 2011, published in December of last year, we predicted a rise to as high as $1.07
– John Kyriakopoulos
Head of currency strategy, NAB
It’s been onward and upward for the Australian against the US dollar over the past fortnight, with the AUD rising three percent to a fresh 29-year high of 1.0584, according to NAB head of currency strategy John Kyriakopoulos.
Last week, the currency gained almost US$0.03 from trough to peak (and was the best performer in the Group of Ten) amid rising confidence in the global economic outlook (reflected in higher commodity prices and stock markets holding onto recent sharp gains) and a widening yield advantage over the US, Kyriakopoulos said.
“Meanwhile, our bullish Australian dollar-Japanese Yen call from late last-year has been vindicated with a 9 percent climb over the past fortnight to our long standing target of 90.00,” he said.
A weaker JPY is part of Japan’s road to economic recovery and while risk-appetite might wax and wane, this fundamental driver of AUD/JPY, along with Australia’s commodity prices remaining historically elevated, suggests the cross will remain well supported.
In the wake of Australia’s blockbuster jobs report on Thursday, traders moved to price a two-thirds chance the RBA will hike rates at year-end, up from 30 percent before the report. In the jobs report, employment rose by a larger-than-expected 37,800, all but 5700 full-time, pushing the unemployment rate down to 4.9 percent. “We had argued that for AUD/USD to hit our long standing forecast of $1.05 would require an RBA (Reserve Bank of Australia) kicker and this has been delivered,” Kyriakopoulos said.
“Meanwhile, it appears that the US Fed won’t be ending quantitative easing mark two early, which has reinforced expectations that US interest rates could remain unchanged this year,” Kyriakopoulos said. The Australia-US two-year swap yield differential has rebounded from 414 basis points last Tuesday (April 12) to 429 bps.
All three drivers of our “fair value” model for the AUD/USD increased last week, Kyriakopoulos said. Investor risk-appetite improved a little further, the Australia-US two-year swap yield spread widened by 15 bps, while the Journal of Commerce Industrial Metals Price Index was up 2.8 percent to a record high.
The current “fair value” estimate is 1.0150 with the one-standard deviation band at 0.9760 and 1.0530.
This was the eighth week this year that “fair value” has been above parity and the year-to-date average is 0.999.
“So how much further can AUD/USD go?,” Kyriakopoulos asks. “In our FX Roadmap for 2011, published in December of last year, we predicted a rise to as high as $1.07. At $1.10, we would be very cautious since the RBA could then hose down official rate hike expectations,” he said.
NAB has acknowledged upside risks to its AUD/USD forecasts for the second half of the year which have the currency averaging around parity ($1.05 by the end of June; $1.01 by the end of September; and $0.98 for the end of December).
“Firstly, the two 25 bps rate hikes by the RBA that NAB forecasts are not priced by the market, which currently assigns only a two-thirds chance of a 25 bps hike at year-end,” Kyriakopoulos said.
“With Australian economic growth starting to pick up we can see further falls in the unemployment rate triggering another step up in RBA rate hike expectations over coming months.”
After several quarters of underlying Consumer Price Index inflation averaging just 0.5 percent quarter on quarter, NAB forecasts a slight acceleration to 0.6 percent QOQ in the first quarter of 2011 (released April 27), suggesting inflation has bottomed.
Secondly, the JPY-funded carry trade could continue to boost demand for the AUD as the Bank of Japan increases quantitative easing (implying Japan’s interest rates will remain at zero for years to come) and the threat of intervention to prevent any strengthening of the JPY persists, Kyriakopoulos said.
Thirdly, the likelihood that the United States doesn’t raise interest rates over the next six months is rising, suggesting a slim possibility of a sharp rebound in the USD.
“As such, we could see AUD/USD spending the next three to six months trading between $1.00 and $1.10,” Kyriakopoulos said.
“There is a good reason not to get too carried away with how much further AUD/USD could climb,” he said. “The trade-weighted value of the AUD is currently 5 percent above the 74 level that underpinned the RBA’s CPI inflation forecasts published in early February. This is a material difference and could moderate the RBA’s inflation outlook, suggesting a less aggressive policy tightening by the central bank”.
The Statement on Monetary Policy will publish updated forecasts on May 6.