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Hawkish minutes won’t change Aussie’s downtrend

Carolyn Hebbard | Flickr | Getty Images

The Australian dollar surged on Tuesday, jumping 0.7 percent against the U.S. dollar to trade at $0.915, after the release of the Reserve Bank of Australia (RBA) minutes lowered expectations of further interest rate cuts in the near future.

However, one strategist argues that the minutes don't change the longer-term downtrend in the commodity currency, forecasting that it will fall to $0.83 by year-end or 9 percent lower from current levels.

"I'm not reading anything in the minutes that argues for a higher Australian dollar, in fact, [it's] the opposite. The RBA is still on an easing bias," said Greg Gibbs, senior FX strategist at RBS, noting that current upside in the currency is likely a result of short covering.

Short interest in the Australian dollar rose to a record high earlier this month, but speculators have cut back their bets against the currency in the recent days, according to market watchers.

The RBA in its minutes for the July 2 policy meeting said a steep fall in the Australian dollar would add a little to inflation over time, but not to the extent that it would hamper another cut to interest rates if needed to support demand.

The central bank also said the economy was growing at a below potential base and the outlook for the business environment remained uncertain.

Markets, however, lowered their expectations for a rate cut in August to a 53 percent chance, down from a 63 percent chance before the minutes were released, according to Reuters.

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The Australian dollar is among the world's worst performing major currency this year, 12 percent against the U.S. dollar so far this year, clobbered by falling commodity prices, a slowdown in Australia's top trading partner China and the prospect of the U.S. Federal Reserve scaling back its monetary support.

Gibbs says while the Australian dollar may stabilize around $0.90-$0.93 in the coming weeks as jitters over slowing China's economy wane, the longer term direction for the currency is down.

"As we approach the Federal Open Market Committee in September, when tapering is likely to begin, and perhaps, we see Chinese growth indicators struggle, the Australian dollar will be heading below $0.90. I am forecasting $0.85 at the end of the third quarter, and $0.83 end year," Gibbs said. Bernanke's congressional testimony on Wednesday and Thursday will be closely watched for clues on timing for tapering.

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He added that the currency, which is among the worst performers this year, will continue to come under pressure from the decline in commodity prices.

"Since April, the Australian dollar appears to be trying to reconnect with weak mining and steel sector equities that have sharply under-performed the broader market since 2011. The Australian dollar has further to go to reflect the under-performance of these sectors since mid-2009," he added.

Thio Chin Loo, senior currency strategist at BNP Paribas agrees that there are still a lot of headwinds facing the currency, which generally moves in tandem with commodity prices.

"The perception is that market players are quite happy to stay in long dollar positions because the direction of U.S. interest rates will be higher down the line, the other one is China. Chinese data that we had out yesterday reaffirmed that growth is slowing down and that will weigh on commodity prices in general," she said.

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Andy Xie, independent economist and former Morgan Stanley's Chief Asia-Pacific economist, also believes the Australian dollar will continue to weaken as it adjusts to the new reality of China's slowing economy.

"The Australian dollar has declined nearly one fifth from the peak. There is much more to come," Xie wrote in a recent publication titled Implications of Diverging Monetary Policies.

"The most vulnerable commodities to China's down cycle are industrial minerals. Since China joined the World Trade Organization, the price of iron ore nearly rose ten times. Australia has benefited enormously from the trend. It suffers most on the way down too. The Australian dollar's adjustment is not half done, in my view," he said.

By CNBC's Ansuya Harjani

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