Could the Australian Dollar Sink Further?
The AUD to USD exchange rate is hovering over the $0.70 precipice and an Australian dollar crash in 2016 is almost inevitable. At least, that’s the conclusion many analysts are drawing following the U.S. Federal Reserve’s recent rate hike.
The Australian dollar was predictably sinking in the wake of the historic U.S. Federal Reserve 0.25% rate hike, the first in seven years. The AUD to USD exchange rate lost more than a penny, settling at the $0.71 line.
Asian stock markets reacted favorably and Australia, which considers itself to be an Asian economy, celebrated the rise in U.S. rates. The Australian S&P/ASX200 index rose 1.46%, driven mainly by the healthcare, utilities, and gold industries.
The Australian Dollar is Teetering Over a Precipice
Fed Chair Janet Yellen was keen on noting that interest rates could be raised four times over the next year, but the increases would remain moderate. The markets took this as a sign of optimism and they reacted to the Fed’s interest rate adjustment as a kind of bullish Christmas comet. This has pushed the U.S. dollar ahead of many currencies of other developed economies, especially the G10 countries and the Australian dollar.
Chart courtesy of www.StockCharts.com
The U.S. dollar could be the star of a sustained rally at the expense of the AUD and a few other currencies from some of the BRICS and other emerging markets. Had the Fed not raised interest rates, it would have weakened the U.S. dollar against rival G10 currencies, including the Australian dollar.
If the short-term AUD/USD outlook is bearish, the AUD longer-term outlook is also bearish. Australian investments collapsed in the third quarter of 2015, cutting growth potential and adding to the depreciation pressure against the AUD. The Reserve Bank of Australia (RBA), the Australian equivalent to the Fed, has few options. The main option, a rate cut, in the context of low inflation and already low rates could only increase the USD/AUD gap.
The RBA, nevertheless, welcomes the lower values of the AUD, having already adapted to the bearish AUD/USD relationship, which has weakened mostly because of Australia’s excessive reliance on the resources sector. The RBA has shifted its goals and now wants to strengthen services and manufacturing in order to support the labor markets. This could see it get used to the new model and find a way to cut interest rates further in the same way that the European Central Bank has done, to act as a stimulus.
Accordingly, the Australian government may support the economic shift with stimulus programs, further weakening the Australian dollar against the greenback, which is more valuable now that Janet Yellen raised U.S. interest rates.
In a note, the RBA stated that the value of its currency has been adjusted to the significant decline in the prices of the main commodities. The RBA kept rates unchanged at the minimum value record of an even two percent, changing its message to the markets. Indeed, the central bank was finally able to see beyond the mining sector, where it noted some economic improvements. (Source: “Lower Bulk Commodity Prices and Their Effect on Economic Activity,” Reserve Bank of Australia, September 2015.)
The Bottom Line on the Australian Dollar
The advantage to the Aussie dollar, meanwhile, and to investors, is that inflation remains low, leaving little room for additional interest rate cuts. Australian analysts are generally agreeing that the low commodity prices make the possibility of an AUD rally unlikely. The dovish tone of Yellen’s comments and the related speed and intensity of the Fed’s monetary tightening cycle do not warrant a bullish argument for the AUD against the USD.