3 May 2016
It's not too late to short AUD – Deutsche Bank
Robin Winkler, Strategist at Deutsche Bank, suggests that today’s rate cut by the RBA goes beyond risk management and it marks a shift in the near-term target from unemployment to inflation.
Key Quotes
“Given stagnant wage growth, the exchange rate will need to do the grunt work in getting core inflation from 1.5% back above 2%. We estimate that the RBA needs a 10% depreciation just to stabilize core inflation into 2017; a return above 2% will likely take more. With only 21bps of further easing priced, we continue to think that the market likely underestimates the magnitude of the fundamental adjustment ahead. Stay short.
The RBA assumes that last year’s depreciation is still working its way into consumer prices. Yet the Bank’s own pass-through estimates suggest the boost has already peaked. On RBA estimates, a 10% depreciation raises core inflation by about 0.5%, with the impact peaking after 9 quarters.
When modeling the cumulative impact of currency movements in the past three years, we find that the contribution to core inflation likely peaked in the first quarter of this year at 0.6%.1 If we held the exchange rate constant from now, this contribution would remain at 0.5% for the rest of the year but then fall off sharply in 2017. The lagged effects of last year’s depreciation are increasingly dominated by this year’s rally.
Hence, the RBA needs significant further depreciation even just to maintain the current inflation boost from past currency movements. A simulated one-off depreciation of 10% would just about do the job. To get to 2%, the RBA would need to rely on other factors such as wage growth, which however has proven insensitive to monetary stimulus in Australia, as in other developed economies. The RBA is therefore likely to need more than a 10% depreciation, consistent with AUD/USD in the low 0.60s. It’s not too late to go short in our view.”
Key Quotes
“Given stagnant wage growth, the exchange rate will need to do the grunt work in getting core inflation from 1.5% back above 2%. We estimate that the RBA needs a 10% depreciation just to stabilize core inflation into 2017; a return above 2% will likely take more. With only 21bps of further easing priced, we continue to think that the market likely underestimates the magnitude of the fundamental adjustment ahead. Stay short.
The RBA assumes that last year’s depreciation is still working its way into consumer prices. Yet the Bank’s own pass-through estimates suggest the boost has already peaked. On RBA estimates, a 10% depreciation raises core inflation by about 0.5%, with the impact peaking after 9 quarters.
When modeling the cumulative impact of currency movements in the past three years, we find that the contribution to core inflation likely peaked in the first quarter of this year at 0.6%.1 If we held the exchange rate constant from now, this contribution would remain at 0.5% for the rest of the year but then fall off sharply in 2017. The lagged effects of last year’s depreciation are increasingly dominated by this year’s rally.
Hence, the RBA needs significant further depreciation even just to maintain the current inflation boost from past currency movements. A simulated one-off depreciation of 10% would just about do the job. To get to 2%, the RBA would need to rely on other factors such as wage growth, which however has proven insensitive to monetary stimulus in Australia, as in other developed economies. The RBA is therefore likely to need more than a 10% depreciation, consistent with AUD/USD in the low 0.60s. It’s not too late to go short in our view.”