Aussie dollar set to test record highs
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Foreign Exchange

Aussie dollar set to test record highs

The optimism that has characterised the start of the year is likely to see the Australian dollar march higher in the coming months.

Morgan Stanley has revised its forecast for AUDUSD up to $1.09 for the first quarter. The bank says the currency will continue to benefit from the response of leading central banks to the global slowdown. Hans Redeker, head of FX strategy at Morgan Stanley, says commodity-related currencies such as the Australian dollar are best placed to benefit from the pro-growth policies of China and the US.

“In Asia, and China in particular, monetary stimulus measures appear to be feeding through,” he says.

“Rebounding leading growth indicators and the prospect of further monetary policy easing globally are likely to keep the high-beta currencies supported in the first half of the year.”

That view is despite the fact that the Reserve Bank of Australia is widely expected to cut interest rates by 25 basis points to 4% at its policy meeting next week.

However, Todd Elmer at Citi believes that domestic factors matter little as far as the value of the Australian dollar is concerned, with global risk appetite by far the dominant driver of the currency.

Indeed, since the onset of the global financial crisis, there have been three substantial downturns in AUDUSD.

First, the pair collapsed from just beneath $1.00 to about $0.60 after the collapse of Lehman Brothers. Second, AUDUSD traded from $0.93 to $0.81 in the spring of 2010 as initial concerns over Europe began to build. Third, a decline from $1.10 to $0.96 was seen in late 2011 as the sovereign debt crisis entered its acute phase.

“Each of these episodes was characterized by a sharp deterioration in risk sentiment, deleveraging among global investors and weaker asset market performance,” says Elmer.

“As such, the sell-offs in AUDUSD were correlated with moves in equities, with peaks and troughs in stocks largely matching those from the currency.”

 AUDUSD has tight correlation with S&P

 Source: EcoWin

In other words, the relative overvaluation of the Australian dollar on a purchasing power parity basis has little influence over the valuation of the currency.

Elmer says that given he expects a continued stabilization in risk appetite as tail risks from the European sovereign debt crisis continue to diminish, this spells a likely move to new cyclical highs for AUDUSD in the quarters ahead.

“With central banks likely to be heavy buyers of the Australian dollar, other sectors risk being caught behind,” he says.

“This means both the magnitude and speed of a rise in AUDUSD could surprise. We believe markets are far too complacent on risks for a move beyond $1.20.”

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