[Editor’s Note: Currency movements are difficult to forecast and affected by many local and global factors. Currency prices – and forecasts – can change quickly due to latest economic data. Do further research of your own or talk to your adviser before acting on themes in this article.]

As seen in the chart below, the $A has been in a broad downtrend since early 2021, albeit with some attempted recoveries. In the main, the story over this period has been the post-COVID rise in inflation and the eventual move higher in global interest rates – especially in the US. The $US also bottomed out in early 2021 and tended to strengthen in recent years given the relative strength in the US economy and greater increase in US official interest rates. 

Aggressive US policy tightening and a resilient US economy could be characterised as the “no landing” scenario.

Yet somewhat perversely, overly strong US economic growth – and the associated policy responses – also produced a competing narrative, which was not supportive of the $A either – namely an eventual “hard” landing via a global recession. 

Indeed, global recessions are rarely great news for the $A as they tend to weaken commodity prices – while encouraging investors to flock to the safe haven $US.

The $A’s bounce back to US68 cents late last year, however, reflected renewed hope of yet another scenario – that of a “soft landing” for the global economy, or falling inflation and interest rates without the need for a recession.

The $A only dropped back to US65 cents recently because ongoing resilient US economic growth pushed out market expectations for when the US Federal Reserve could cut interest rates – as opposed to renewed fears that, as in 2022 and 2023, the Fed might raise them further. 
 

What lies ahead?

Despite the $A’s recent drop, a soft-landing scenario for the global economy looks increasingly likely, in Betashares’ view – in which case the $A could start to trend higher over 2024 and into 2025. 

A soft landing favours the $A for several reasons. The absence of a global recession is good news for commodity prices. Having raised rates more aggressively than most in recent years – helping push up the $US and push down the $A - the US Federal Reserve will now likely also cut them by more. 

Last but not least, improved global risk sentiment under a soft-landing scenario would likely reduce the safe haven appeal of the $US.

A potential bonus supportive factor could be China. Although China’s post-reopening recovery has been somewhat lacklustre, reflecting an ailing property sector, its demand for iron ore has remained firm thanks to still-strong steel production to service the manufacturing and infrastructure sectors. If China eventually moves to stimulate its economy more strongly, or current extreme pessimism around China eases, it could be $A-positive, in Betashares’ view. 
 

Soft landing?

So why the optimism around a soft landing? For starters, although global inflation remains higher than desired, there’s no question it’s fallen notably from peak levels of late 2022. This reflected an easing in goods inflation as the initial lockdown-related surge in demand passed and global supply chain bottlenecks unclogged. 

The subsequent disappointing lift in service sector inflation has kept overall inflation high. This appears to reflect the pass-through of earlier energy and goods-related inflation, along with the same type of transitory supply-demand imbalances that afflicted the goods sector during the lockdowns. However, with demand for services in previously hot areas such as travel and eating out normalising, the need to ration services through price increases is also moderating.  

In what’s been dubbed “immaculate disinflation”, labour cost increases have also broadly eased, without a significant increase in unemployment, as higher interest rates and chronic labour scarcity finally convinced businesses to give up bidding for workers they simply could not find.  

Importantly, longer-term inflation expectations remain well-anchored and there’s little evidence of a more enduring third stage of inflation caused by a self-reinforcing global wage-price spiral, in Betashares’ view. 

In a sense, therefore, much of the post-COVID burst of inflation we’ve experienced appears to be a one-off adjustment in price levels to ration the limited supplies of first goods, then services, as economies went into lockdown then re-opened. A surge in food and energy prices following Russia’s invasion of Ukraine only aggravated the situation for a time.

Helpfully, higher interest rates have dampened demand at the margin, limiting the surge in inflation and containing fears that inflation would simply be allowed to run away.
 

Risks

Of course, risks remain. The lagged effects of past policy tightening could still lead to a sudden slowing in global economic growth and renewed “hard landing” recession fears. But provided inflation is heading in the right direction, these fears should be short-lived as it would encourage central banks to cut rates earlier and more deeply.

The other lingering risk is “no landing” – or that labour markets and consumer demand remain too strong, limiting further inflation declines. But inflation risks should be contained by today’s generally better-supplied markets, and the reassertion of the same structural forces for low inflation – globalisation and technology disruption - that existed prior to the COVID imbalances.
 

What does this all mean for the $A, and for investors?

Assuming global economic growth holds up and lower inflation allows central banks - especially the US Federal Reserve - to cut interest rates, there’s a good chance the $A can strengthen further in 2024, in Betashares’ view. This has several implications for investors. 

While avoiding a global recession is no doubt great news, one offset is that a stronger $A tends to hurt listed company earnings - as more listed companies tend to export than import and a given level of foreign exchange earnings will be worth less in $A terms. As such a stronger $A, all else constant, will tend to favour importers in the retailing sector over exporters in the resources or health care sector. 

Another implication is that the value of unhedged global investments – such as equities – would decline in $A terms, compared to the equivalent hedged exposure. As a result, investors might consider increasing exposure to currency-hedged international investments if they believe the $A will continue to appreciate.

From a macroeconomic perspective, a firmer $A will tend to dampen import prices, making it more likely inflation will keep falling and thereby allow the Reserve Bank to eventually cut interest rates. 

A strong $A also makes it a good time to travel overseas, especially to the US, with each Aussie dollar buying a little more in New York or Los Angeles.

DISCLAIMER

This article contains general information only and does not take into account any person’s objectives, financial situation or needs. It is provided for information purposes only and is not a recommendation to make any investment decision or adopt any investment strategy.

The content is for educational purposes only and does not constitute financial advice.  Independent advice should be obtained from an Australian financial services licensee before making investment decisions.

There are risks associated with an investment in Betashares Funds. Investment value can go up and down. An investment in any Fund should only be made after considering your particular circumstances, including your tolerance for risk. For more information on the risks and other features of a Betashares Fund, please see the relevant Product Disclosure Statement and Target Market Determination, available at www.betashares.com.au.