Further to fall as events conspire to drive dollar down

The Australian dollar has fallen from about $US1.05 to $US0.89 during the past year – a fall of 15 per cent, and nearly 20 per cent down from its 2011 high.

The drivers of the slump have been a combination of lower commodity prices, increasing evidence that Australia is not competitive internationally, a deterioration in Australia’s relative growth outlook, falling Australian interest rates, and, more recently, the US Federal Reserve’s move to slow down its monetary stimulus. Reserve Bank of Australia ‘jawboning’ has also helped.

Despite periodic bounces, like that earlier this month, our assessment is that more downside lies ahead.

The big secular picture

The big-swings in the value of the Australian dollar line up well with key long-term swings globally.

• In the 1980s and 1990s, the $A fell as commodity prices softened on stronger supply, global investor sentiment shifted in favour of the US, and Australia was seen as ‘old economy’. As a result the $A fell to $US0.48 in 2001.

• In the 2000s the $A surged as commodity prices rose (driven by China and the emerging world and weak commodity supply), the US and Europe hit hard times, Australia was seen as being in good shape and the $US generally fell. The $A peaked in 2011 at $US1.10.

• The secular picture is turning again. The US, Europe and Japan seem to be tracing out a renaissance of sorts at a time when parts of the emerging world seem to be running into difficulties. Slower growth in the emerging world, led by China at a time of increased commodity supply, is weighing on commodity prices; as a result, the $A is trending down as the $US trends back up.

Central to these long-term swings as far as the $A is concerned is the commodity super cycle. This is because 70 per cent or so of Australia’s exports are commodity related. Raw material prices over the past century have undergone a roughly 10-year secular or long-term upswing, followed by a 10 to 20-year secular bear market.

The upswings are usually driven by a surge in global demand for commodities after a period of mining underinvestment. The downswings come when the pace of demand slows but the supply of commodities picks up in lagged response to the previous price upswing. The last commodity super cycle that got under way around 2000 looks to have run its course. Growth in China remains strong but it has slowed from 10 per cent-plus to between 7 per cent and 8 per cent at a time when the supply of commodities is surging after record levels of mining investment globally. And a basing in the $US is also not helping, as commodities tend to be priced in US dollars.

Just as the upswing in the $A lasted a decade, the downswing could last as long. But how far will the $A fall?

Dollar drivers

Several factors point lower for the $A. The major factors on this front are commodity prices, relative monetary policies, and changing perceptions of Australia.

As already noted commodity prices are in a secular downswing. Added to this, monetary policies are now working against the $A with the RBA cutting interest rates since late 2011, which has reduced the interest rate differential favouring the $A when the US Fed is slowing its quantitative easing program.

Finally, perceptions of global investors about the $A appear to be changing. For much of the past decade perceptions were positive, reflecting Australia’s favourable fundamentals tied to growth in the emerging world and more latterly as a AAA-rated safe haven against turbulence in the US and Europe. Now there is a bit more wariness as emerging markets have gone out of

favour and Australia’s budget deficit has deteriorated.

While the RBA appears to have relaxed its efforts at talking the $A lower, this may simply reflect the extent of the fall that has already occurred. Coming at time when short positions in the $A are extreme, the change in the RBA’s stance could bring a further short-term bounce in the $A as short positions are unwound. However, it doesn’t change our broader assessment that the trend in the $A will be down.