The five reasons why the $A is likely to rise further – if recession is avoided
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After a soft patch since 2021, there is good reason to expect the $A to rise into next year
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Key points
– After a soft patch since 2021, there is good reason to expect the $A to rise into next year: it’s undervalued; interest rate differentials look likely to shift in favour of Australia; sentiment towards the $A is negative; commodities still look to have entered a new super cycle; and Australia is a long way from the current account deficits of the past.
– There is a case for Australian-based investors to remain tilted a bit to hedged global investments but while maintaining a still decent exposure to foreign currency.
– The main downside risks for the $A would be if there is a recession or a new Trump trade war.
Introduction
Changes in the value of the Australian dollar are important as they impact Australia’s international export competitiveness and the cost of imports, including that of going on an overseas holiday. They are also important for investors as they directly impact the value of international investments and indirectly impact the performance of domestic assets like shares via the impact on Australia’s competitiveness. But currency movements are also notoriously hard to forecast. Late last year it seemed the $A was at last on a recovery path but it topped out in December and slid back to $US0.64. Lately it’s been looking stronger again getting above $US0.67. So maybe the five reasons we thought would drive the $A higher in a note last November (see here) are at last starting to work?
The $A has been weak since the mining boom ended
But first some history. Way back in 1901 one $A bought $US2.40 (after converting from pounds to $A pre 1966), but it was a long downhill ride to a low around $US0.48 a century later. See the blue line in next chart.
The $A is below fair value baed on relative prices
Source: RBA, ABS, AMP
Thanks to the mining boom of the 2000s, the $A clawed back to $US1.1 by 2011, its highest since the 1981. But since 2011, the $A has been mostly in a downtrend again briefly hitting a low around $US0.57 in the pandemic after which there was a nice rebound into 2021 up to near $US0.80 but with weakness quickly resuming. The key drivers of the weakness since 2011 have been: the end of the commodity boom; increasing worries about the outlook for China which takes around 35% of Australia’s goods exports; a narrowing gap between Australian and US interest rates (which makes it less attractive for investors to park their cash in Australian dollars); and a long term upswing in the value of the $US generally. See the next chart.
The $US v major currencies & the $A
Source: Bloomberg, AMP
But there remain five reasons to expect the $A to rise
Back in November we saw five reasons to expect a higher $A. These largely remain valid and the $A seems to be perking up again.
Firstly, from a long-term perspective the $A remains somewhat cheap. The best guide to this is what is called purchasing power parity (PPP) according to which exchange rates should equalise the price of a basket of goods and services across countries – see the red line in the first chart. If over time Australian prices and costs rise relative to the US, then the value of the $A should fall to maintain its real purchasing power. And vice versa if Australian inflation falls relative to the US. Consistent with this the $A tends to move in line with relative price differentials – or its purchasing power parity implied level – over the long-term. This concept has been popularised over many years by the Big Mac Index in The Economist magazine. Over the last 25 years the $A has swung from being very cheap (with Australia being seen as an old economy in the tech boom) to being very expensive into the early 2010s with the commodity boom. Right now, it’s modestly cheap again at just above $US0.67 compared to fair value around $US0.72 on a purchasing power parity basis.
Second, after much angst not helped by another US inflation scare, relative interest rates might be starting to swing in Australia’s favour with increasing signs that the Fed is set to start cutting rates from September whereas there is still a high risk that the RBA will hike rates further. Central banks in Switzerland, Sweden, Canada and the ECB have already started to cut rates. Money market expectations show a narrowing of the negative gap between the RBA’s cash rate and the Fed Funds rate as the Fed is expected to cut by more than the RBA. As can be seen in the next chart, periods when the gap between the RBA cash rate and the Fed Funds rate falls have seen a fall in the value of the $A (see arrows – and this been the case more recently) whereas periods where the gap is widening have tended to be associated with a rising $A. More broadly the $US is expected to fall further against major currencies as US interest rates top out.
The interest rate gap between Aust & the US versus the $A
The dashed part of the rate gap line reflects money mkt expectations. Source: Bloomberg, AMP
Third, global sentiment towards the $A remains somewhat negative, and this is reflected in short or underweight positions. In other words, many of those who want to sell the $A may have already done so, and this leaves it susceptible to a further rally if there is any good news.
$A positioning remains short
Source: Bloomberg, AMP
Fourth, commodity prices look to be embarking on a new super cycle. The key drivers are the trend to onshoring reflecting a desire to avoid a rerun of pandemic supply disruptions and increased nationalism, the demand for clean energy and vehicles and increasing global defence spending all of which require new metal intensive investment compounded by global underinvestment in new commodity supply. This is positive for Australia’s industrial commodity exports.
Long term bull and bear markets in commodity prices
Source: Bloomberg, AMP
Finally, Australia’ current account surplus has slipped back into a small deficit as commodity prices have cooled and services imports have risen (particularly, Australian’s travelling overseas) but it remains much better than it used to be over the decades prior to the pandemic. A current account around balance means roughly balanced natural transactional demand for and supply of the $A. This is a far stronger position than pre-COVID when there was an excess of supply over demand for the $A which periodically pushed the $A down.
Aust current account surplus remains in better shape
Source: ABS, AMP
Where to from here?
We expect the combination of the Fed cutting earlier and more aggressively than the RBA, a falling $US at a time when the $A is undervalued and positioning towards it is still short, to push the $A up to around or slightly above $US0.70 into next year.
Recession & a new Trump trade war are the main risks
There are two main downside risks for the $A. The first is if the global and/or Australian economies slide into recession – this is not our base case but it’s a very high risk. The second big risk would be if Trump is elected and sets off a new global trade war with his campaign plans for 10% tariffs on all imports and a 60% tariff on imports from China. If either or both of these occur it could result in a new leg down in the $A, as it is a growth sensitive currency, and a rebound in the relatively defensive $US.
What would a rise in the $A mean for investors?
For Australian-based investors, a rise in the $A will reduce the value of international assets (and hence their return), and vice versa for a fall in the $A. The decline in the $A over the last three years has enhanced the returns from global shares in Australian dollar terms. When investing in international assets, an Australian investor has the choice of being hedged (which removes this currency impact) or unhedged (which leaves the investor exposed to $A changes). Given our expectation for the $A to rise further into next year there is a case for investors to stay tilted towards a more hedged exposure of their international investments.
However, this should not be taken to an extreme. First, currency forecasting is hard to get right. And with recession and geopolitical risk remaining high the rebound in the $A could turn out to be short lived. Second, having foreign currency in an investor’s portfolio via unhedged foreign investments is a good diversifier if the economic and commodity outlook turns sour as over the last few decades major falls in global shares have tended to see sharp falls in the $A which offsets the fall in global share values for Australian investors. So having an exposure to foreign exchange provides good protection against threats to the global outlook.
Dr Shane Oliver – Head of Investment Strategy and Chief Economist, AMP
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.
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Tess has over 22-years experience in Chartered Accounting Firms and in this time has had a broad range of experience in superannuation, taxation, business services, and financial strategy.
Over the last seven-years, Tess has turned her attention to Financial Planning, earning a Diploma of Financial Planning in 2015 and leading the newly established financial division of the Wybenga Group as a director of Wybenga Financial.
Tess’s mission is to bring the ethics and integrity of her Chartered Accounting background to the area of wealth management.
As a woman in a male dominated field, Tess is active in promoting gender equality in the industry through various programs and mentoring opportunities.
Using her depth of knowledge and experience in tax and accounting Tess is able to demonstrate a level of competence that is unique in the Financial Planning sector.
2001 – Commenced employment with Wybenga & Partners and part-time accountancy studies
2004 – Graduated Masters of Commerce from the University of New South Wales
2005 – Admitted as an Associate Member of the Institute of Chartered Accountants Australia
2007 – Promoted to Manager at Wybenga & Partners
2012 – Appointed as Associate Director
2015 – Awarded a Diploma of Financial Planning
2016 – Appointed as Partner of Wybenga Group and Director of Wybenga Financial
Schedule a Meeting with Tess
Adam Roberts
B.Bus, B.Sc, CA, DipFP
Adam has over 18-years experience in Chartered Accounting Firms and in this time has had a broad range of experience in superannuation, taxation, business services, and financial strategy.
Over the last seven-years, Adam has turned his attention to Financial Planning, earning a Diploma of Financial Planning in 2015 and leading the newly established financial division of the Wybenga Group as a director of Wybenga Financial.
Adam’s mission is to bring the ethics and integrity of his Chartered Accounting background to the area of wealth management.
Combining traditional accounting and financial services has been a welcome move for Adam, allowing him to operate and advise in the financial sector that has been a long time personal passion.
Using his depth of knowledge and experience in tax and accounting Adam is able to demonstrate a level of competence that is unique in the Financial Planning sector.
2005 – Graduated Bachelor of Science from the University of Western Sydney
2005 – Commenced employment with Wybenga & Partners and part-time accountancy studies
2007 – Graduated Bachelor of Business from the University of Western Sydney
2010 – Admitted as an Associate Member of the Institute of Chartered Accountants Australia
2010 – Promoted to Manager at Wybenga & Partners
2012 – Appointed as Associate Director
2015 – Awarded a Diploma of Financial Planning
2016 – Appointed as Partner of Wybenga Group and Director of Wybenga Financial
Schedule a Meeting with Adam
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What is an Advisory Cadetship? An Advisory Cadetship enables you to commence your career whilst attaining the necessary university qualifications by studying part-time.
How does it work? Generally, our cadets complete a relevant business or accounting degree at the University of New South Wales, the University of Technology Sydney, Macquarie University, or the University of Western Sydney.
The Firm provides 3-hours paid study leave per week to attend university. This can either be taken at the one time or broken between days depending on the individual’s requirements. In addition, the Firm provides paid study leave for both mid-semester and end-of-year exams.
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What are the benefits of an Advisory Cadetship with Wybenga Financial? Our cadets benefit from the following:
Career path – on completion of their degree our cadets have significant practical experience which will assist them in advancing their careers
Work helps your studies – by working full-time our cadets are able to apply their practical knowledge in the university subjects
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Modern environment – including ‘socialising’ areas such as pool table and break out area
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What happens when I complete my degree? The completion of your degree is the first step of what we hope to be a long and successful career with us. The next step is the commencement of a Diploma of Financial Planning followed by completing the requirements to become a Certified Financial Planner (CFP).
There are always progression opportunities for the right cadets and we are dedicated to the long term development of our staff.
Who should apply? Current Year 12 students or first/second year University Students who:
want to commence their career in financial advisory;
are due to commence or are currently completing a part-time business or commerce degree at university with an advisory major;
want to gain valuable hands-on experience while completing their qualifications;
are looking for a friendly working environment;
are team players who display initiative;
have a commitment to self-development;
possess excellent personal presentation and communication skills; and
are motivated and mature minded.
How do I apply for an Advisory Cadetship? To apply for a Cadetship position at Wybenga Financial send us your details. Please also include in your covering letter why you wish to do a cadetship, include relevant qualities you possess, main interests / achievements, and any previous employment.
Interested candidates should initially forward a resume/covering letter of no more than 3-pages. Please provide full details of contact information (telephone or e-mail).
What if I have more questions? For further information about our Cadetship program, please send your enquiry to .
