In line with our expectation, the Reserve Bank of Australia (RBA) left its official cash rate at its historic low of 1.5% for the 17th consecutive meeting since it is of the view that the current levels will ensure growth remains sustainable apart from adopting the wait-and-see attitude on the direction wage growth and inflation. We feel that with the unemployment rate at 5.5% in January 2018, which is well above the 5.0% mark, it will take time to build potential upwards wage pressures. Hence, the current interest rates will remain at record-low levels for a while as inflationary pressure will pick up albeit slowly.

How will the Aussie dollar perform against the USD? We feel the AUD will be influenced by: (1) commodity prices; and (2) relative interest rates. Using these two drivers, our fair value is around 0.78 against the USD. However, there are some risks for the Aussie dollar to weaken slightly against the USD in 2018 to around 0.75-0.77 due to: (1) China’s GDP, which is expected to slow to 6.4%; (2) a possible slight weakening in commodity prices; and (3) the RBA being “out-hiked” by the US Fed again in 2018, in which we are looking at three rate hikes and possibly even four.

Despite pricing in the risk factors, our base case view is that there is little doubt that a weak trend in the USD will cushion the Aussie dollar from falling materially against the USD. Improving trade position, belated consolidation in the fiscal budget and now a less vulnerable AAA credit rating suggest a less likely sharp fall in Australia’s exchange rate against the USD. We project the AUD to trade around the 0.78 level against the USD in 2018 while expecting some volatility along the way in 2018. Against the Malaysian ringgit, we expect the Aussie dollar to trade around 2.99 – 3.02 level while on the downside, it should hover around 3.04 – 3.07.

• In line with our expectation, the Reserve Bank of Australia (RBA) left its official cash rate at its historic low of 1.5% for the 17th consecutive meeting. The last time the RBA reduced its official cash rate was in August 2016 by 25 basis points (bps).
• The reason for the RBA to leave rates unchanged is because it is of the view that the current levels will ensure growth remains sustainable. Besides, the RBA plans to adopt the wait-and-see attitude to determine if there are any signs of gradual improvement in wage growth and inflation.
• In our view, the unemployment rate, which is at 5.5% in January 2018, is well above the 5.0% threshold. Hence, we feel it may take some time for unemployment to reach the 5% mark. On that note, the current interest rates are poised to remain at record-low levels for a while as inflationary pressure will pick up albeit slowly.

• How will the Aussie dollar perform against the USD in 2018? In our assessment to determine the fair value of the Aussie dollar, we felt it will be influenced by two key factors i.e. (1) commodity prices; and (2) relative interest rates. By using these two drivers, we derived a fair value of around 0.78-0.79 against the USD, which suggests there is evidence of some strengthening mode.

• However, we believe there is some risks for the Aussie dollar to weaken slightly against the USD in 2018 to around 0.75-0.77. Downwards pressure will come from: (1) China’s GDP, which is expected to slow to 6.4% in 2018 from 6.9% in 2017; (2) a possible slight weakening in commodity prices; and (3) the RBA being “out-hiked” by the US Fed again in 2018, in which we are looking at three rate hikes and possibly even four. Indeed, Australia’s 10-year bond yield is now trading below that in the US.

• Despite pricing in the risk factors, our base case view is that there is little doubt a weak trend in the USD will cushion the Aussie dollar from falling materially against the USD. Improving trade position, belated consolidation in the fiscal budget and now less vulnerable AAA credit rating suggest a less likely sharp fall in Australia’s exchange rate against the USD.

• We project the AUD to trade around the 0.78 level against the USD in 2018 while expecting some volatility along the way in 2018. Against the Malaysian ringgit, we expect the Aussie dollar to trade around 2.99 – 3.02 level while on the downside, it should hover around 3.04 – 3.07.

Source: AmInvest Research - 7 Mar 2018