Australia’s dollar is likely to drop below 70 U.S. cents next year as a struggling economy forces the central bank to reduce interest rates by as much as half a percentage point, according to BlackRock Inc.
While the Reserve Bank of Australia is a “reluctant cutter,” weak business capital spending will probably push policy makers into lowering the cash rate by a quarter point in either September or October from a record-low 2 percent, said Stephen Miller, head of Australian fixed income at the world’s largest asset manager. They could cut again in 2016 if the situation fails to improve, he said.
The RBA is grappling with an economy that’s suffering from a plunge in commodity prices and looking for alternative sources of growth following a drop in mining investment. At the same time, it’s wary of fueling Sydney house prices that RBA chief Glenn Stevens has labeled “crazy.” The currency’s 17 percent tumble in the past year has still left it above where the central bank says it needs to be to support growth.
“The economy has some really challenging headwinds,” Miller said in an interview on Friday in Sydney. “70 cents, I still see that as a reasonable target by the end of this year and I think it probably goes lower in 2016.”
The Aussie bought 77.75 U.S. cents as of 1 p.m. on Monday in Sydney, more than 3 percent above the six-year low it reached in April. The median estimate in a Bloomberg survey of forecasters shows it falling to 73 cents by the middle of 2016.
The interest-rate differential between Australia and the U.S. will also narrow as the improving American economy allows the Federal Reserve to start raising its benchmark, something BlackRock says is most likely to begin in September.
Prices for key exports such as iron ore should also “remain challenged,” Miller said. Australia’s terms of trade was 28 percent below its 2011 peak at the end of March, according to government data.
“The reality is when you get a negative terms-of-trade shock the economy generally has a serious stumble and I don’t see why it should be any different this time,” Miller said.
Miller reckons the RBA is optimistic, although not unrealistic, in predicting an economic expansion of 2.75 percent to 3.75 percent in 2016. The central bank has forecast growth of 2.5 percent for 2015.
RBA board member John Edwards told a conference in Canberra on Tuesday that the country has a problem with slow growth and the currency is still too high.
While BlackRock’s longer-term strategy is to bet that the Aussie dollar will fall and that Australian bond yields will decline relative to other advanced economy markets, Miller isn’t ready to “put the house on it” just at the moment.
“I suspect the market is still short Aussie dollars, I suspect the market is still long Aussie rates, but when we get some clean out in positioning and it looks a bit clearer, and you get some compelling entry levels to put on those sorts of trades, that’s the time to do that,” he said. “We’ve got some tiny positions on now.”
The Australian 10-year bond yielded 2.90 percent on Friday, 61 basis points more than similar-maturity U.S. Treasuries. Miller reckons that gap could be “closer to 25” by early 2016 if things play out as he expects.
Swaps traders were pricing in a 32 percent chance of at least one rate cut by September and about a 48 percent probability for November, according to data compiled by Bloomberg.
One of the key concerns helping to stay the RBA’s hand at this stage is concern that home prices have risen too quickly in Sydney, the nation’s largest city. Miller believes the gains stem more from local factors such as a lack of housing supply and the centralization of jobs in the inner city, and that the boom shouldn’t prevent further monetary easing.
“We’ve got a period of exuberance in house prices in parts of Sydney, some pockets of strength in Melbourne,” and not much happening elsewhere, he said. “Monetary policy is not meant to be about Sydney house prices and bits of Melbourne, it’s meant to be about the country as a whole.”
Ultimately, ongoing weakness in business investment is likely to sway the RBA board and the next release of official capital expenditure figures on Aug. 27 may be the catalyst for their next move, according to Miller.
“I can’t conceive that they’ll show much of a better picture, if indeed any better picture, and I expect that sometime after the release of those numbers the RBA will cut again.”