Anxiety that a Tweet-trigger happy US President-elect Donald Trump could spark a trade war at any moment will keep the Australian dollar below 75¢ versus the US dollar, say Westpac currency strategists.
The Australian dollar, which fell to a seven-month low of US71.76¢ late last year after trading above US77.60¢ before the US election, is about as cheap as it has been over the last decade, according to Westpac's "fair value" models. But, in a note to clients published on Friday, Westpac's Robert Rennie said the bigger risk was "a global geopolitical recession or near vacuum".
"There is a keen sense in the market that we are just one tweet away from another tumble," he wrote.
Australia's open, trade-reliant economy and its economic ties to China have made the currency a favoured way for traders to express views on the impact of trade policies and their impact on economic growth.
An inward-looking US administration, agonising in Britain over Brexit, a series of elections in Europe and a major Party Congress in China "renders the world's geopolitical architecture volatile at best", Mr Rennie wrote. That, coupled with further risks around Russia's position in the Middle East and North Korea's nuclear ambitions, means the Australian dollar will retain its status as the "go-to liquid risk proxy".
"Then overlay a keen sense that we may be just one tweet away from a China/US trade spat, and we would argue that strength in the $A should be strongly capped by US74.5¢-US75.0¢."
Westpac says the local currency is cheap for a number of reasons. Its "fitted fair value" model, which takes into account interest rate differentials, commodity prices and market-based measures of risk sentiment, says the current level of the Australian dollar is 8 per cent cheaper than it should be.
The divergence from fair value may reflect uncertainty relating to the US position on China, tariffs and trade, "the outcome of which is critically important to the Australian dollar". The currency also isn't fully reflecting the strength in commodity prices with many key exports such as coal and iron ore recovering to multi-year highs.
Westpac also says data has sent a "clear message" that "the global economy fared better than most people expected last year" despite several unsettling macroeconomic events, which should result in a stronger currency.
Westpac expects two interest rate hikes from the US Federal Reserve and no change from the Reserve Bank, which will narrow interest rate differentials and favour a weaker Australian dollar.
The bank also believes that while the currency underprices the appreciation in commodities, they are likely to fall in 2017 – which will lead its models to assign lower values to the currency.
