The following is an extract from our quarterly outlook, published 23rd June 2014. I’ve included a table of forecasts at the foot of the blog.
We’ve long been of the opinion that both carry and also commodity prices were becoming less key for the Aussie. These two factors had been defining factors in explaining the Aussie performance over recent years. Returns from carry trades have struggled for most of the post-crisis period as the Aussie had looked increasingly over-valued, but the carry offered was also slimmer.
The changes in commodity dynamics have been evident for some time now. The old dynamic was that the Australian currency was just nothing more than a proxy for China. Exports of iron ore to China are still up over 40% over the past year (similar for coal), so it’s not as if Australia is seeing this dependency decline. But what is happening is that this is becoming less important in dictating the direction in the Australian dollar. This change in dynamic we have written about on several occasions, such as “Explaining Aussie Resilience”.
The central bank went from actively trying to talk down the currency in December 2013, to taking a more neutral stance this year. They continue to observe that the exchange rate “remains high by historical standards” in their rate decision statements. This shift in stance cannot be ignored, so we take a more neutral to slightly softer view of the currency for the second half of 2014. It’s likely that the Aussie will depreciate, more in the fourth quarter, but this will be more modest compared to expectations at the beginning of the year.