JPM Key drivers of positive AUD view

JPM Key drivers of positive AUD view

 JP Morgan forecasts a solid macro backdrop for the
AUD. We expect inflation to remain elevated through the
end of 2013 (consistently above 3.0%, the upper band of
the RBA’s target zone). The introduction of the carbon
price in July of this year will constitute an important
temporary factor boosting inflation.

 Further, we forecast solid GDP prints of 3.1% in 2012
(with growth accelerating from 2.8% in Q1 to 3.7% in
Q4) and 3.2% in 2013. These projections are in line with
the RBA’s, which will be updated on Feb 10.

 Last month the RBA cut the cash rate by a further 25 bps
(following the 25 bps reduction in Nov). Their discussion
was focused on three arguments against cutting: the
Australian economy is projected to grow at a pace
broadly in line with trend (as discussed above); the
domestic mining capex boom; and Australia’s main
trading partners (i.e., China and China) are still recording
solid growth.

 Overwhelming these arguments was the RBA’s
obsession with the downside risks posed by Europe.
Absent concerns about the debt crisis, the RBA would
likely be raising policy rates towards neutral (about
5.0%), which would be very bullish for the AUD.

Risks to our view
 The AUD is the highest beta G10 currency and is
especially vulnerable to three external risks: deterioration
in the Euro debt crisis; global growth surprising on the
downside; and an underwhelming policy response
leading Chinese growth to disappoint.

 The two key domestic risks are a bust in the miningrelated
capex boom and the Dutch disease. The RBA
emphasizes that mining capex has been profoundly
robust, growing by over 50% during the past year, with
the outlook projected to be at least as impressive.
Massive expansions to iron ore and coal production
capacity are underway, and a pipeline of $150 billion in
LNG projects is now approved or under construction. A
decline in Chinese commodity demand (70% of
Australia’s iron ore exports head to China, up from 20%
ten years ago), could quickly mark the end of the party.
The unprecedented mining capex boom might then
appear extravagant and wasteful, causing the outlook to
be downgraded suddenly and acutely.

 Additionally, the RBA stresses that the outlook for the
non-mining economy remains subdued, partly due to the
strong AUD. There are numerous signs of weakness
outside the mining sector, manifestly evident in sector
level employment and profits data, all classic Dutch
disease symptoms. Resource exports now account for
60% of the total, more than twice the level of a decade
ago, as the non-commodity exporting sectors get
squeezed. Non-mining sectors constitute 92% of the
economy and, according to the Australian Industry
Group’s CEO, Australia is “currently in the midst of a
boom (mining) and gloom (everything else) economy”.
Such unbalanced growth is inherently risky.

JP Morgan Forecasts AUD

Potential trigger events AUD

Short-term model for AUD/USD
 Our short-term model estimates AUD/USD around 0.98,
6% below today’s level.
 Key explanatory variables include: 2Y yield spread and
the CRB metal index.

Medium-term model for AUD/USD
 Our medium-term model estimates AUD/USD at 0.94,
which is 10% below today’s level. AUD could get hit
very hard if bearish risk scenarios materialize.
 Model is based on a 10yr spread, Chinese manufacturing
PMI, global manufacturing PMI, and the RBA
commodity index.

Technicals
 The medium term view is unchanged as the broad
consolidation phase is expected to continue in the months
ahead. Importantly, the reversal from the October and
November lows has affirmed the .9400 area as critical
support defining the medium term range lows. Again, we
continue to view the 1.10/1.11 zone as the upper
parameter to this medium term consolidation given the
reversals from the May/July highs.

 Short term, the advance from the November and
December lows has led to a break through the key 1.04
area, but we note that prices are quickly approaching the
next line of key resistance levels near 1.0680/1.0765.
This area includes the 76.4% retracement of the decline
from 1.1083 July’11 peak, as well as the critical double
top from September/October. In turn, prices are likely to
struggle against this area leading to another downswing
within this broad consolidation phase particularly as the
deep oversold setup from November has been unwound.
Support at the 1.0225/1.0145 zone which includes the
early-January low will define whether a deeper pullback
is underway. Alternately, an extension above the 1.0765
area should allow for a closer test of the 2011 highs.