Australian And New Zealand Dollars: Some Room For Appreciation

Supportive economic backdrop

Global factors have dominated the economic performance in Australia and New Zealand over the past couple of years. These two Oceanian countries, owing to a large share of their economic activity linked to the export sector and commodities, are classic examples of economies whose economic performance strengthens when global growth is strong. Indeed, Australia and New Zealand experienced strong growth in 2017 on the back of higher terms of trade amid strong Asian demand and recovering domestic economies. For 2018 and 2019, we expect the Australian economy to advance by around 3% while New Zealand is also set to pursue solid growth at the same pace.
In Australia, demand for metals boosted export prices, with rising iron ore, gold and copper prices. Over the coming year, metal prices are expected to remain buoyant even though global economic conditions are likely to ease and China is expected to pursue its soft landing.
In New Zealand, the export sector is also expected to remain a key contributor in 2018 and 2019 with its main exports, i.e. dairy products and agricultural products being more and more in demand in China. 

Risks to our economic outlook

While commodity prices remain a tailwind at this stage, it is also a risk factor and a source of uncertainty going forward. A faster-than- expected deceleration in Chinese economic growth is a risk. China’s slower growth is more likely to put downward pressure on Australia’s key commodity prices  than New Zealand’s.
The second risk to the outlook is the housing market. Real estate prices have largely increased in both countries where household indebtedness have grown substantially in the past years. A real estate correction would hamper domestic consumption and purchasing power.

Positive outlook for the Australian dollar

Since the beginning of the year, the Australian dollar has depreciated versus the US dollar with the AUD/USD moving from 0.78 to 0.74 currently (value of 1 AUD). The bulk of the weakness can be attributed to the stronger US dollar in recent months while the Federal Reserve’s monetary policy tightening also played a large role.
Our scenario is two more rate hikes in the United States in 2018 and two in 2019 while the Reserve Bank of Australia is priced for two rate hikes at the beginning in mid-2019. As a result, monetary policy divergence should continue to grow. Nonetheless, beyond the rate hikes, monetary policy expectations have played a larger role for currencies in recent quarters. As the Reserve Bank of Australia is yet to turn more bullish while future steps of the US monetary policy are already well anticipated, we see more potential for the Australian monetary policy to impact the exchange rate.
Other factors that have displayed an important correlation with the AUD exchange rate are the commodity prices, in particular iron ore prices. We hold a globally neutral view on metals but still believe that prices are likely to remain supportive for the AUD.
Overall, global factors and Australia’s monetary policy should be in favour of a stronger AUD. Given that metal prices are also expected to be supportive and that the domestic economy should continue to grow at a rapid pace, we revise our 3-month target to 0.76 (from 0,78) and our 12-month target to 0.80 versus USD (from 0,76) (value of 1 AUD). 

We also like the New Zealand dollar

So far this year, the New Zealand dollar has been broadly following the path taken by the US dollar index. The NZD initially appreciated along USD weakness and recently depreciated as the USD strengthened.
We expect the global economic backdrop to be strong in the coming year, which should be supportive for the NZD. The Reserve Bank of New Zealand has recently suggested that the next rate hike will probably be only in the third quarter of 2019 and the market is currently discounting this outcome. Given the still subdued inflation and wage growth, we see it as unlikely that the RBNZ will bring forward its next rate hike. We however think that a rate hike is probable in the last part of 2019, supporting the NZD next year as the case for a tighter policy builds up.
Overall, we think that the still supportive global economic demand,  the central bank being a bit more hawkish in 2019 and the expected weakening of the US dollar should lead to a stronger NZD. We revise up our 3-month forecast to 0.70 in 3 months and to 0.72 in 12 months versus USD (from 0.71 for both) (value of 1 NZD).