AUD to target 0.72 by end 2018 - Westpac

Bill Evans, Research Analyst at Westpac, points out that Westpac has revised its forecasts for the US Federal funds rate and the Australian dollar and they now expect three (from two) FED hikes in 2018 and have changed their target (end 2018) for the AUD from USD0.70 to USD 0.72.

Key Quotes

“Critically, we retain our expectation that the USD will appreciate through.”

“When we last produced our forecasts in mid-December we expected that the Federal Funds rate would be increased by 25 basis points in June and December in 2018 to reach 1.875% by year’s end.”

“We envisaged “neutral” as zero real and expected that “zero real” would be sufficient to allow the FED to go on hold through 2019 as other major central banks, particularly ECB and BOJ, embarked upon their own tightening programs.”

“Associated with that higher Federal Funds rate would be a rising bond rate and rising US dollar with targets of a rise of around 5.5% in the USD Index (DXY) and an increase in the US 10 year bond rate to 3% from 2.35% at the time.”

“Associated with that expected increase in the USD; an expected fall in Australia’s Commodity Price Index of around 20%; and a deteriorating yield differential as the RBA remains on hold in 2018 we expected a fall in the AUD from around USD 0.765 to USD 0.70.”

“This commodity view, which seems at odds with the current surge in global optimism is partly based on our below Consensus forecast for Chinese growth in 2018 (6.2%, down from 6.8%) as the authorities slow investment growth and embrace more aggressive financial reform.”

“In a surprising development the USD Index has in fact depreciated by around 4% since mid-December despite a sharp widening in the US yield differential, (the US 10 year rate has increased from 2.35% to 2.62% and the three year rate has increased from 1.95% to 2.17%).”

“In response to this lower starting point for the USD and the expected impact on business investment from the accelerated depreciation allowances in the US tax package we have raised our forecast for growth in the US economy to 2.5% from 2.2% in 2018.”

“Lower tax rates; a lower USD; and a subsequent 6% lift in the US share market have markedly eased financial conditions (despite higher bond rates) clearing the way for a FED rate hike in March.”