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Sustained period of negative Aus-US rate spreads - Westpac

Bill Evans, Chief Economist at Westpac, projects a sustained period of negative Australian vs US rate spreads, which should lead to a move down to USD 0.68 in 2019, with downside risks. 

Key Quotes

The US economy is operating with much less ‘slack’ in its labour market (unemployment rate of 4.1% compared to a estimated full employment rate of 4.75%) than Australia (unemployment rate of 5.5% compared to a full employment rate of 5.0%) but little wage pressure has emerged.

Over the course of 2017 the USD has fallen by around 8% despite four rate hikes since December. With financial conditions also easing via a 20% rally in the US equity market, the Fed has seized on the opportunity to raise rates in anticipation of rising inflation.

Without access to an effective macro-prudential policy (due to the highly regionalised and low concentration of lenders in the market) it has relied on higher rates to deal with the threat of financial instability.

We expect that process to continue in 2018 with two more 25 basis point hikes in June and December.

That would see the AUD/USD yield differential in the overnight market contract to minus 38 basis points – a situation we have not seen early 2000. A heavy toll will be taken on the AUD with the currency forecast to fall to USD 0.70 by the end of 2018.

With upward pressure on the USD in 2018 and inflation remaining benign we expect that the Fed will hold rates steady through 2019 ensuring that the negative yield differential with Australia holds through 2019 and that the AUD will fall further.

We expect a move down to USD 0.68 in 2019, with downside risks.

Author

Ivan Delgado

Ivan Delgado

Independent Analyst

Established in the Asian continent since 2009, Ivan studied a degree in Business at the University Pompeu Fabra (Barcelona), while also earning a postgraduate degree in Business Administration.

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