Despite higher interest rates in the United States and ongoing weakness in commodity prices, the Australian dollar has broadly trended sideways since late 2015. This note updates our model estimates of fair-value for the $A against the US dollar in light of recent interest rate developments and the December quarter terms of trade results. Although we find that the $A is now closer to fair value (based on current fundamentals), it still seems likely to eventually break below its recent range as fundamentals continue to evolve.
$A Range Bound As RBA Stays On Hold
As seen in the chart below, the $A’s decline flattened out somewhat over the latter part of 2015, with prices meeting consistent resistance at just under US70c. At the same time, the $A has also tried and failed to rally much beyond US73c, leaving the currency range bound. At around US71c, the $A is currently around the middle of recent range.
Despite weaker commodity prices, the $A seems to have taken some heart from the resilience of the local labour market – with the unemployment rate declining to below 6% – which in turn allowed the RBA to leave official interest rates comfortably on hold since May 2015.
$A Close to “Current” Fair Value
That said, it’s also true that the $A is less clearly overvalued than it used to be. To assess fair-value, I’ve updated my fundamental $A model – which is largely based on the same methodology as the RBA – and covers both the terms of trade and inflation-adjusted interest rate differentials between Australia and the United States. Previous model updates are provided here and here.
As seen in the chart below, largely reflecting the continued steady decline in the terms of trade, our estimate of ‘fair-value’ for the $A declined to around US70c in the December quarter of 2015, compared with US73c in the June quarter 2015 and US78c in the December quarter of 2014.
Evolving Fundamentals Still Favour Further $A Weakness
At the same time, the United States Federal Reserve is still likely to raise interest rates further this year due to low unemployment and some lift in wages growth, while the RBA retains a bias to cut interest rates further. As and when the local housing sector turns down further – as I expect – the RBA will likely act on this bias in the second half of 2016, unless the $A has already by then fallen by a long way.
Either way, the likely evolution of fundamentals would seem to favour downside in the $A over the coming year.
The BetaShares US Dollar ETF (ASX:USD)
Investors wishing to express a view that the $US will continue to rise against the $A can do so using our BetaShares US Dollar ETF (ASX:USD). USD aims to track the change in price of the United States dollar relative to the Australian dollar, before fees and expenses. For example, if the $US goes up 10% against the $A (i.e. the $A falls in value) the ETF is designed to go up 10% too before fees & expenses (and vice versa). For many investors, the Fund offers this exposure at a much cheaper cost than using a traditional foreign currency bank account (for a comparison see here.) Betashares also offers two other currency ETFs providing exposure to the Euro and British Pound.
For those investors seeking offshore unhedged equity market exposure, moreover, BetaShares, currently offers two products providing exposure to the US equity market – the FTSE RAFI U.S. 1000 ETF (ASX:QUS), and the S&P 500 Yield Maximiser Fund (managed fund) (ASX: UMAX). The links provide further information on these Funds.