In the past week, we have seen two different views on the Australian dollar (FXA) from official government sources.
Last week, the Australian Government Bureau of Resources and Energy Economics (BREE) delivered its Resources and Energy Quarterly for June Quarter 2013. This report includes a 12-month projection for the exchange rate of the Australian dollar versus the U.S. dollar.(click to enlarge)
Australian dollar projection
In the report, the BREE notes that the market is expecting further declines in the Australian dollar. Accordingly, the BREE projects an average exchange rate of 0.94 over the next 12 months. Of course AUD/USD is already below that level (at the time of typing, poor retail sales numbers drove the exchange rate to 0.90). I think this average is based on a range of 0.86 to 1.02. The BREE called the 1.02 - 1.03 average for the last 12 months "high," so I am taking that as the top of the range going forward. I take the difference of the maximum (1.02) and the average (0.94) and subtract from the average to get the lower bound of 0.86. I think a much lower level is supported by the BREE's consideration of a scenario with an Australian dollar lower than the 0.92 level quoted as of June 24th:
"The market view is that the Australian dollar is expected to decline in value, or depreciate further, relative to the US dollar over the next 12-18 months…Should the Australian dollar decline below the assumed exchange rate of 0.94 US dollars per Australian dollar, there would be additional support for the value in Australia dollars of export commodities denominated in US dollars."
The BREE did not provide a forecast of the exchange rate in the report from a year ago. Without that data, I could not use BREE's past forecast accuracy to further refine this presumed range of 0.86 to 1.02. I strongly suspect that the market can and will overshoot as far as the low from 2010 around 0.80. Something in the next 12 months seems certain to freak out markets enough to drive a fresh sell-off in risk/commodity currencies like the Australian dollar.
Last year, the BREE was really focused on the risk factors from Europe as an explanation for the decline in the Australian dollar at that time. I placed the emphasis in the quote below because it represents a rare direct and official acknowledgement that rate cuts CAUSE declines in the exchange rate:
"The recent fall of the Australian dollar from a peak of US108c and TWI [trade-weighted index] 79 in late February 2012 is a result of interest rate cuts by the Reserve Bank of Australia (RBA) in the second quarter of 2012.
There are several important drivers of the Australian exchange rate over the near term. Factors that would make the Australian dollar relatively weaker include a continuation of the euro zone recession; reduced demand for China's exports to Europe; improved economic activity in the US; lower economic growth in China; and further interest rate cuts by the RBA in 2012."
Fast forward to today and the story of a weakening Australian dollar has moved past issues in Europe and even rate cuts from the Reserve Bank of Australia:
"In recent months the Australian dollar has depreciated relative to the US dollar. This can be attributed to several factors. First, lower than expected growth in the Chinese economy in the first quarter of 2013, although China is still experiencing rapid GDP growth of about 7.5 per cent. Second, the prices of some key commodities exported from Australia have fallen in US dollar terms. Third, the real interest rate differential between Australia and the US has declined over the past few quarters. Fourth, [quantitative] easing initiated in the US in response to its severe recession following the GFC is expected begin to taper off before the end of 2013 and possibly end by mid 2014 if the US unemployment rate trends downward as expected."
I think it is relatively safe to assume that the RBA is pretty close to the end of its rate-cutting cycle. Of course, given its interest in a much lower currency, the RBA is not likely to admit this. In its most recent monetary policy decision on July 1, 2013 the RBA stuck to its conclusion that the inflation outlook may provide the RBA scope for further rate cuts "…should that be required to support demand."
In this statement, the RBA was finally more direct in seeking a lower exchange rate:
"The Australian dollar has depreciated by around 10 per cent since early April, although it remains at a high level. It is possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy."
In other words, the RBA is not satisfied with the steep drop over the past three months. By noting the positive benefits of a further devaluation, the RBA is finally giving a direct reason explaining why the exchange rate should decline. Past statement releases have not included such an explanation. The reference to a rebalancing economy represents a page torn right out of the book of Mervyn King, out-going Governor of the Bank of England (BOE).
Putting this all together, I have decided to get more aggressive in bearish trades against the Australian dollar with a focus on fading rallies - chasing the Aussie down only risks getting caught in a sharp bounceback or relief rally. I think the BREE has provided a great roadmap for determining when it no longer makes sense to stay aggressively bearish on the Australian dollar. If I ever become bullish in the coming 12 months, I will use parity (1.0) as an upside target.(click to enlarge)
The Australian dollar's 3 months of near non-stop selling has taken it to 33-month lows against the U.S. dollarSource: FreeStockCharts.com
Be careful out there!
Additional disclosure: In forex, I am net neutral on the Australian dollar