Chief economist update: AUD misdirection

Early New Year predictions  the Australian dollar would depreciate by the end of 2019 have been given a boost by the International Monetary Fund's (IMF) 'World Economic Outlook, April' report where it shaved its world GDP growth forecast to 3.3% this year - down from the 3.5% rate predicted in January 2019 and 3.7% forecast in October 2018.

The IMF "projects a slowdown in growth in 2019 for 70% of the world economy ... It reflects negative revisions for several major economies including the euro area, Latin America, the United States, the United Kingdom, Canada, and Australia".

Then again, negative revisions are more negative than others. The IMF re-calibrated Australia's GDP growth rate by 0.7 percentage points - to 2.1% this year from 2.8% it predicted only six months back. This compares with downgrades (from October forecasts) of -0.2% for the US; -0.6% for the euro area; -0.3% for the UK; and, -0.5% for Canada.

No prize for guessing but this is in light of the sharp deterioration in Australia's property market. Quoting Thomas Helbling - the International Monetary Fund's (IMF) lead analyst for Australia - the Australian Financial Review (AFR) printed that, "It's in a delicate situation. In terms of general direction, we're not surprised [prices have fallen] ... That said, [the] downturn has been a bit bigger."

This echoes HSBC currency strategist Tom Nash's rationale when he predicted  the Australian dollar would end 2019 at US$0.66 a couple of months earlier:

"...Unlike 2018 when broad-based US dollar strength and, towards the end of the year, global growth concerns, acted to drag the Aussie lower ... the main factor that will undermine the Aussie this year will be far closer to home: potential spill-over effects from the unwind in Australia's housing market boom," he said.

"While the risks around [a deterioration in the external environment, particularly China], appear to have receded for now, this may be masking the growing risks from the second, which is gathering momentum and deserves more attention. The deceleration in the flow of housing credit has been evident since at least early 2018 but has only recently come into focus due to a flurry of weakness in indicators of domestic demand."

That certainly looks likely, especially if one extrapolates the downtrend in the Australian dollar since the beginning of 2018 where it depreciated by 10% versus the US dollar and by 6.5% on the trade weighted index (TWI) for the full year.

However, 2019 trading activity in the local currency shows that it's undergoing a reversal. This year to date, the A has risen by 2.0% against the greenback to US$0.7178 and by 0.5% on the TWI to 63.44.

Australia-US interest rate differentials don't explain this. Short-term interest rates remain as they were at the end of 2018 - the RBA's official cash rate is 1.5% and the Fed funds rate at 2.25%-2.5%. The status quo is also preserved with regards to interest expectations. Despite policy guidance from the Fed that it will keep interest rates on ice for the remainder of 2019 and the RBA is presently on a neutral bias, both are expected to cut interest rates this year.

Perhaps, the only explanation to the AUD's resilience is the 2019 rebound in commodity prices. After dropping by 15.4% in 2018, the S&P GSCI commodity price index has rallied by 20.9% this year to date - a bull market if you will.

While this would certainly improve Australia's terms of trade, the sharply weakening property market, tepid wage growth and household consumption dictates the RBA would need to cut interest rates sometime this year.

Read more: International Monetary FundTom NashThomas Helbling
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