Aussie dollar set to slide below US70c – or is it?

If there is one question that is perplexing Australian investors at the moment it is the level of the Australian dollar.

After some heavy selling this week and an almost 4 per cent drop, there is no shortage of pundits predicting that the Jumbuck could fall to US70c or below before the end of this year, with some even predicting it will head to US65c and below in the next 12 months.

Then again, there are other players that still predict the dollar will remain fairly steady or even reverse its recent weakness.

Aussie dollar vs US chart slide 70c
AUD vs USD chart.

Knowing the direction and extent of any falls in the dollar is crucial information for all investors, even from the most basic metric of what percentage of offshore investment assets should be held.

It becomes even more important when you need to know everyday things such as the outlook for commodities (which are priced in US dollars), gold, travel, the need for currency hedging and especially when you are involved in currency trading.

However, currencies are notoriously difficult to predict with any certainty so skewing investment towards – for example – Australian gold miners on the basis that they will become more profitable with a much lower currency is fraught with danger.

The main danger being that the currency might go the other way but also that the gold price might not behave as expected due to many other variables such as inflation.

What the dollar bears think

The number of dollar bears has rapidly been growing as more groups jump aboard the momentum of the weakening trend in the Australian dollar.

Fund manager Pendal group was one, with a prediction that the Aussie will fall more than ten per cent to the mid US60c’s in the next 12 months.

Pendal has form for successfully riding currency trends, having bought Turkey credit default swaps in May just before investors dumped the nation’s assets on economic worries.

Giant global fund manager BlackRock agrees, predicting a slide to US70c this year and the potential for further weakness after that.

Westpac Banking Group has also predicted that the dollar may drop to US70c in 2019.

The reasons the dollar bears cite are very similar but can basically be summarised as:

– The US is rapidly raising official interest rates, pushing them up seven times since December 2015 and flagging at least another couple of rises to come soon. Those rising rates open up an interest rate differential with Australia, which has held rates steady at 1.5 per cent, with the Reserve Bank being in no rush to raise rates as housing prices in the main markets of Sydney and Melbourne fall.

– Australia’s largest trading partner, China, is vulnerable in the escalating trade war with the US, with any signs of an economic slowdown in China sure to be reflected in a weaker Australian currency as well.

– As US interest rates rise, funds will be attracted to the higher yields on 10 year bonds in the US and away from countries with lower 10 year bond rates, such as Australia, reinforcing the current currency trend of a stronger US currency and a weaker Australian dollar.

– Slowing Australian lending growth as the Australian property market continues to cool off will add further downward pressure to the Australian economy and the currency.

What the dollar bulls think

Despite the growing number of dollar bears, that view is by no means universal.

Many other groups including at different times in the past few months Credit Suisse, Maybank and CBA have remaining more bullish on where the dollar could end up.

CBA has even predicted that the dollar could rise as high as US83c before the end of the year, although that call was made before the current bout of renewed weakness which has seen the dollar fall below US74c.

The reasons put forward by the dollar bulls can be summarised as:

– Chinese growth is not as fragile as anticipated and as it rebounds the price of iron ore will rebound with it.

– Other commodity prices are also riding higher which is positive for the Australian dollar, particularly the major Australian export LNG, which is being buoyed by higher oil prices.

– Having fallen significantly already, the Australian dollar is overdue for a rebound.

Of course there is a third possibility – the Australian dollar will continue to trade relatively sideways with slight oscillations as the bulls and bears wrestle for control.

At the end of the day every investor and trader needs to come to their own conclusion about the currency and which way it is heading and why.

Over the very long run and with a suitably balanced portfolio the currency may not even be as big an issue as it sometimes appears.

However it is human nature to try to look for trends and to get a benefit from them and for those with a short term investment and trading position, the Australian dollar is one of the really big variables that can make a very large difference.

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