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The View from the Outer

View from the outer: A$ - crouch, touch, pause, engage

Max Casey Tim Rocks Peter Dragicevich
14th May 2020

A$: crouch, touch, pause, engage

After touching its lowest level since the early 2000s, the A$ has snapped back to be roughly in line with where it was trading ahead of the market turmoil. The question now is where do we see the A$ going?

 

Near-term we think there is scope for the A$ to pull-back given the potential for the market’s optimism to be tested. Based on the recent higher than normal correlation between the A$ and global equity markets, a deterioration in risk sentiment via an adjustment of expectations around the speed of the global reopening/recovery, a spike in infections (particularly in the US), or a pickup in US/China geopolitical tensions could exert some downward pressure on A$. 

 

But given policy measures that have been deployed to improve market functioning and alleviate US$ funding pressures, we believe any A$ downside should be more contained. In our view, investors should opportunistically use dips in the A$ down towards US$0.60-0.62 to reduce US$ exposures.

 

This is pertinent because in contrast to the near-term, we think there are upside risks to our longer-term A$ outlook. FX is a relative price, so relative economic fundamentals matter. While we expect economies to generally endure elongated recoveries, comparatively, thanks to its rapid health response, and large scale and targeted policy measures Australia looks better placed to come out of the current shock more robustly than others such as the US. Case in point, projections are for Australia’s labour market to not deteriorate as much and to heal a bit faster than the US. Historically, relative labour market trends have been a good guide for medium-term A$ direction.

 

More broadly the US$ now looks far closer to the end than the beginning of its multi-year upcycle. The US$ remains overvalued on a PPP basis and the US$ Real Effective Exchange Rate is well above average. Given the lower interest rate structure, the US$ may need to downwardly adjust in order to attract the capital inflows needed to fund the US’ burgeoning twin deficits (i.e. current account and budget balance).