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Economic and Financial Market Update: The Big Dollar

02 November 2020

Summary:

The RBA is highly likely to cut rates again in November;
The new policy announced will be QE (RBA buying Government bonds to reduce rates);
Over the next few months there is a risk that the $A might fall under 70c;
But over the next 6-12 months I still look for the AUD to head towards 75c.

The good news is that there has been good news. The news flow on potential vaccines has been good. It looks likely that Australian GDP growth will be strong in both the September and December quarters as a result of the re-opening of state economies. After a slow few months the Chinese consumer has got regain enough confidence to get out there and start spending again.

But momentum in the economy (outside of Victoria) appears to be slowing. This apparent loss of momentum is troubling given the amount of spare capacity in the economy. One result is that the RBA will provide further assistance. This is likely to be a (small) reduction of interest rates. And also include a QE program (buying Federal and State Government 5-10 year bonds).

The AUD has been one of the weaker currencies over the past month. A key reason has been the change in tone by the RBA over the past few weeks. But also the $US has held up. There is thinking that bigger budget deficits could see a weaker $US. But there has been relatively little movement in the current account deficit. This means the aggregate amount of overseas financing needed for the US economy has not significantly changed.

In the short term there are reasons to think that the Euro may weaken. And given the size of the Euro currency market, if the Euro weakens it often means the $US strengthens. And if that happens there is the clear risk that the $A could head lower, and potentially break 70c. But the bigger picture is that the $US looks overvalued. Over the next 6-12 months I still look for the $A to head higher towards 75c.