In our experience, commodity markets are far more volatile than you ever expect. The $A is a case in point. We changed our minds on the direction of the $A on 10 January this year when we wrote ‘In contrast to 2007, it appears that the $A may be supportive to Australian grain prices in 2008'. But a couple of RBA rate hikes and aggressive easing by the US Fed had many commentators suggesting that the $A was heading to parity.
On 21 February, we wrote ‘We feel that the US is close to recession, or entered recession at the end of last year… Around mid-2008, the US will be finished cutting rates, and the $US should start recovering into the second half of this year. Continue to watch for the $A to ease into the mid to low 80s by year’s end as the $US begins to recover.’ If we wrote it today, we couldn’t have put it better!
The drivers of the $A retreat have been: $US strength, lower commodity prices and global growth forecasts, a weakening in the outlook for our interest rate differential, a sharply weaker domestic growth environment and some unpopular moves by our rookie federal government (carbon and wealth taxes).
China may not save us
With the engine that has driven the stellar performance of the $A slowing (China’s blue-sky demand for our commodities), and other bits and pieces starting to loosen (strong interest rate differentials, and strong domestic economy), it is hard to see how the $A will mount another attack on parity.
But don’t expect the $A to continue to fall at the same rate it has done in the last month. Our strong terms of trade will support the $A at well above its longer-term average of 72US¢. The recent slump in demand for hard commodities may be arrested when manufacturing in China resumes after the Olympics. But growth for the next couple of years will be constrained compared to the previous couple.
The fate of the $US could well determine how far the $A falls. We suspect that the US economy will have to negotiate a few more hurdles before it finds its feet again.
Watch for the $A to ease into the mid to low 80s by year’s end as the $US begins to recover. Deeper than expected cuts to local interest rates or further shocks to world growth could drive the $A below 80US¢. A quick resumption in world growth, a turnaround in commodity values or further easing in US interest rates (all unlikely in our view) may be the catalysts for the $A to buck the lower trend.
If you are interested in receiving this information and more on a regular basis, please call us toll free on 1300 302 143 to organise your subscription.
Click HERE to subscribe online or Click HERE for a 4-week FREE Trial