The Aussie dollar may have fallen steeply over the past 12 days but Goldman Sachs reckons the currency is set for a rebound that could possibly take it over the US80¢ level if commodity prices sustain some of their recent strong gains.
In a surprisingly upbeat note on the Australian economy, Goldman Sachs chief economist Tim Toohey upgraded his GDP growth forecasts for the coming four years by as much as 0.5 percentage points and said there was a growing chance the Reserve Bank would start lifting interest rates in the second half of 2017, which should all support the currency.
![Despite the mini-boom in commodity prices, the Aussie dollar has over the past months hardly strengthened.](/web/20161121045157im_/http://www.smh.com.au/content/dam/images/g/s/s/h/v/d/image.related.articleLeadwide.620x349.gstuyd.png/1479702140286.jpg)
"As we look out to 2017 and beyond, we believe Australia has moved through an important transition point and with it has emerged the prospect of stronger and less volatile real economic growth," Mr Toohey said in the note which forecasts the economy will grow 2.8 per cent in 2017, 2.9 per cent in 2018, 3.0 per cent in 2019 and 3.3 per cent in 2020.
Key for Mr Toohey's optimism – in marked difference to Macquarie, which last week downgraded its economic forecasts for Australia, predicting two rate cuts early next year – is the unexpected surge in commodity prices, which has seen coking coal prices jump by 300 per cent this year and iron ore rise 80 per cent.
This has transformed the investment bank's expectation for a modest rise in Australia's terms of trade in 2017 to a solid 8 per cent gain, with most of the export price spike to be registered in late 2016 and early next year. Mr Toohey said this shift was likely to set off a chain of events through the economy in coming months:
- The mining sector's profit cycle is now much stronger than previously factored into analysts' and policymakers' baseline scenarios
- The taxation windfall awaiting the federal government is sufficiently large to distance the prospect of a sovereign ratings downgrade and indeed provides some scope for the government to think more seriously about its own infrastructure objectives as funding constraints ease
- Idled capacity in industries such as coal production is likely to be brought online and plans for investment will be progressively reassessed
- Employment and income certainty will begin to rise, helping to underpin consumption via lower household saving rates and in time helping to support a gradual turning in wage growth
- Consumer inflation will start to rise as the combination of higher input costs and stronger global and local demand filters down to inflation expectations.
"In many ways this is the reverse of the forces that have been in play since Australia's terms of trade peaked in 2011," Mr Toohey said.
Perhaps the most dramatic transformation would come via Australia's external accounts with a run of trade surpluses now in prospect for 2017, he said.
![Australia's terms of trade could post their biggest jump on record this quarter.](/web/20161121045157im_/http://www.smh.com.au/content/dam/images/g/s/u/0/r/d/image.related.articleLeadwide.620x349.gstuyd.png/1479702140286.jpg)
"Indeed the combination of stronger commodity prices and the ramp-up of LNG production suggests Australia will post the largest trade surpluses as a share of GDP during 2017 since any time since the early 1970s. Ultimately the state of the external accounts is the truth serum for the currency, and as such we acknowledge clear upside risk to the A$ from current levels."
The recent rise in the value of coal and iron ore forecasts by the end of 2017 is equivalent to 1.4 per cent of GDP, Goldman's commodities team has calculated, adding that should coal and iron ore prices hold at spot levels until the end of 2017 this would be equivalent to a a $52 billion revenue windfall, which is equivalent to a 3 per cent boost to nominal GDP.
![There's been a big disconnect between surging commodity prices and the Aussie dollar.](/web/20161121045157im_/http://www.smh.com.au/content/dam/images/g/s/t/u/j/1/image.related.articleLeadwide.620x349.gstuyd.png/1479702140286.jpg)
This boom is different
Other economists predicted the commodity price resurgence would have a shorter and less positive impact on the Australian economy than previous price increases.
"Commodity producers have not responded to rising commodity prices like they have previously. Investment in new greenfield projects remains subdued despite spot prices hovering well above incentive prices – particularly in iron ore and coal markets," CBA commodities analyst Vivek Dhar said in a note to clients on Monday.
Producers were responding to higher commodity prices by restarting idled operations, such Glencore's Integra coking coal mine, where the capital cost was low and the return more immediate, he said, adding that miners were also looking to return their cash back to shareholders, reducing debt or investing in further cost reduction initiatives.
While he didn't believe in another resources-led renaissance of the economy, Mr Dhar said he still expected the Aussie dollar, budget revenues, company profits and nominal GDP to get a boost from the higher terms of trade, signalling an end to risks of slowing income growth.
Mr Dhar said it was possible the rise in commodity prices, particularly iron ore and coal, could boost Australia's terms of trade by a record 16.4 per cent in the fourth quarter (from the previous three months), if spot commodity prices stayed at their current levels. But he predicted the rise would likely be a bit below the current record of 14 per cent as commodity prices moderate over the rest of this quarter.
Dollar caught in crossfire
Despite the mini-boom in commodity prices, the Aussie dollar has over the past months hardly strengthened – and since the US election the currency has actually lost nearly 6 per cent to just above US73¢, due to rising US bond yields as global investors bet a Trump stimulus plan will lift inflation and prompt the Federal Reserve to hike US interest rates more aggressively.
"The Aussie dollar has been caught in the crossfire between the strong rise in commodity prices and the sell-off of yield-based strategies which global investors had expressed in Australian assets," Mr Toohey acknowledged.
"However, as the wash-out in yield strategies matures we believe forex investors will take up the narrative of a sharply improving trade balance, improving private sector demand indicators and the risk that the RBA contemplates hiking rates in 2017 as key reasons for the Australian dollar to commence an upswing."
That has led Goldman to upgrade its forecasts for the Aussie from US75¢ and US72¢ on a three- and 12-month view to US78¢ and US75¢, respectively. Mr Toohey sees this as a conservative forecast, explaining his caution with the rising US dollar trend, a further unwind in yield-based strategies and incremental declines in coal and iron ore prices from late 2016 spike levels.
"Nevertheless, we now see very limited downside risk for the A$ and considerable upside risk. Indeed, a spike in the $A through US80¢ cannot be ruled out."
Mr Toohey still reckons it's more likely the RBA will start lifting interest rates in early 2018, but he says the skew is now towards an earlier kick-off in the second half of next year.
"At this stage we have kept our forecast for the RBA to commence its hiking cycle in 1Q18 with the RBA forecast to increase interest rates 75 basis points through 2018 and a further 75 basis points spread over 2019 and 2020 to a 3 per cent cash rate.
"Nevertheless, the risk of the RBA increasing the cash rate in 2H17 has risen materially and the evolution of financial conditions, house prices and underlying inflation will ultimately guide the decision."