Australian dollar to bounce back, says BNP Paribas analyst

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This was published 9 years ago

Australian dollar to bounce back, says BNP Paribas analyst

By Vesna Poljak

One of the few experts to correctly call the Australian dollar's super-charged run in the first half of 2014 is predicting it will perform strongly again next year and be better off in the face of a US dollar rally than the euro, Japanese yen and Swiss franc.

BNP Paribas's global head of foreign exchange strategy, Steven Saywell, made waves in late 2013 when he made a call that the Australian dollar would fetch a high value in 2014, defying consensus and going against a stream of forecasters who were rushing to downgrade the currency.

"The Australian dollar doesn't look that overvalued any more.": BNP Paribas' Steven Saywell.

"The Australian dollar doesn't look that overvalued any more.": BNP Paribas' Steven Saywell.Credit: Nic Walker

He was right. Since the London-based strategist issued a "sell" recommendation at US93.5c last month, and following sustained weakness, he is arguing that the Australian dollar has another year of strength ahead and for the same reason he was bullish in late 2013: yield.

By end of 2015, BNP's forecast is US86¢, rallying to US90¢ by the first quarter of 2016.

But first, Saywell explains what motivated him to turn bearish in September.

"What's critical here is the US dollar is turning and that's what's driving markets. With respect to Aussie the reason we turned quite bearish a month or so ago was Aussie was looking very overvalued particularly versus rates. We put a lot of emphasis on positioning and the market was very long Aussie dollars – and by the market I mean really US and European real money and hedge fund investors. This was a combination that looked very vulnerable. It's a classic case for a big move.

"From here I would argue from a relatively near-term perspective both those factors have neutralised themselves. Australian dollar doesn't look that overvalued any more, it's fallen pretty much to the level that interest rate differentials would suggest in the short term, and lo and behold that long position in the market has come completely out back to almost neutral."

Neutral positioning means the market is not overly long or short in its bets and implies that a currency is more resistant to bad news.

"If I stand back from Australia and take a global view, the [US] dollar is appreciating and it is appreciating against the low-yielding currencies: the ones that are keeping rates at zero and doing QE and that is yen, euro and Swiss franc. These are the low-yielders, or the funders," Saywell says. "Aussie's a bit different in the sense it's not hiking rates like the US is. In contrast it's certainly not doing [quantitative easing] and it doesn't have anything like zero rates."

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The US dollar's appreciation, by the same token, will be "far less aggressive" against the Australian dollar than it will be against euro, yen, and Swiss franc.

"Aussie is far more insulated," Saywell says. Under years of Federal Re­serve quantitative easing, where the central bank printed money to buy US Treasury bonds and weakened the greenback, the US dollar tended to fall against all currencies, almost indiscriminately. It's a reflection of the dominance of the Fed in global markets, and the almost $US4 trillion that was deployed through QE.

Even that dynamic is set to change.

"Now you've got a more normal situation where the US dollar is rising because of a normal macroeconomic environment where rates are responsive to data," says Saywell. So the nuances of policy settings and interest rates will count.

BNP sees the Fed hiking interest rates in the second quarter of 2015.

NEXT YEAR IS DIFFERENT

For the time being, the Australian dollar could go moderately lower, he believes, because the US dollar could rally further. Next year is different. "Everything's about policy divergence," he says. BNP, for example, has sterling outperforming the US dollar because the Bank of England will beat the Fed to tightening. So with this is mind, is the Australian dollar a "hiking" currency or a "dovish-easing" currency?

"If the market starts to price in a rate hike from the RBA any time soon that's going to support Aussie," says Saywell. "Aussie dollar is super-sensitive to rate hikes, more so than to commodity prices." He points to how the Australian dollar has resisted the full force of the plunge in the iron ore price, Australia's number one export, which is down 35 per cent this year versus the currency's decline of a few cents.

BNP has the RBA's first rate hike coming in 2016. "If we're right, and the next move in Australia is up, and that move is in 2016, we start to price that in and I think Aussie will start to move higher. I'm ­backing away from the uber-bearish call on Aussie and I think we start to go higher again."

Long-term fair value for the Australian dollar is US94¢ according to BNP, an outcome that would worry the RBA no end given the RBA's view that fair value lies in the low US80¢ range. Saywell's estimate (enhanced in time by the role of liquefied natural gas exports) gives the currency impetus to trade above US90¢ in 2015 and 2016.

Central bank flows support the case for a strong Australian dollar, he added. "They're not particularly after currency appreciation, but in a world where there's no yield in Europe, there's no yield in Japan, it's a big event. So again central banks and sovereign wealth funds are increasingly after alternatives to the dollar and the euro because it's a bit of a duopoly out there and Aussie has stood out as one they like."

Japanese investor flows add to the case. "Japanese investors are looking abroad," he says. "At a retail level, Japan has a soft spot for Australia. I get this from investors all the time: Japanese investors like the idea of investing in Australia. It's traditionally seen as a high-yield market, it's seen as safe, they come here on holidays and they know it. It's a brand."

Saywell pointed to the precedent set by the New Zealand dollar and its foundation in the Reserve Bank of New Zealand's interest rate settings. "Clearly they were the first central bank to hike and in a market seeking yield that has pushed the currency up. The whole tone of what we're saying here is that yield differentials [dominate]."

He questions whether RBNZ's jawboning of the NZ dollar – so far effective – could have a lasting impact, much like the RBA's efforts. "You could argue that the market ultimately goes with the fundamentals; talking the market down has a limited impact You're not going to change the direction of the currency if you're going against the fundamentals would be my view. If [the RBNZ] hikes rates the currency's going to go back up. It's a very similar situation with Australia."

And Saywell does not believe the current uproad in Australia over house prices will elicit a tightening from the RBA.

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