Will the Australian dollar really drop to US 40 cents?

There has been plenty of speculation regarding the Australian dollar and how much it will be worth, but few (if any) forecasts have gone as low as US 40 cents, until now.

The local currency has been on a wild ride so far in 2016. It plunged as low as US 68.28 cents in January; threatened to rise above US 80 cents in April, and bottomed out at around US 71.8 cents again in May. It’s once again fetching US 74.2 cents on Friday, although it did rise above US 75 cents after the Reserve Bank of Australia left interest rates on hold earlier this week.

Those sharp ups and downs are highlighted in the chart below:

Source: Yahoo! Finance

Source: Yahoo! Finance

The direction of the Australian dollar depends largely on three things, which have all contributed to the movements seen in the chart above so far in 2016:

  1. The Australian economy: things such as employment, inflation or housing data, as well as business and consumer confidence can indicate where the economy is headed, and how much growth to expect.
  2. Commodity prices: our growth also depends on commodity prices, given the amount of tax revenue that comes from the miners. A falling iron ore price is seen as particularly bad for the economy.
  3. Interest rates: investors around the world seek the highest returns, and will put their money where they can earn the highest returns. Higher US interest rates would attract investors back to the United States, but the US Federal Reserve has been slow to act in lifting rates. At the same time, the Reserve Bank of Australia is hesitant to cut interest rates, keeping many investors attracted to the Australian currency.

As is always the case, it’s impossible to tell where the currency will go in the short term, and it could even rise towards US 80 cents again for all I know. But one leading fund manager is much more bearish than that and suggests the dollar could drop below US 50 cents in the not-too-distant future.

According to The Sydney Morning Herald, Vimal Gor, who is head of income and fixed interest at BT Investment Management, believes it’s only a matter of time before foreign investors realise how overvalued the Australian dollar is.

At the same time, Gor believes the RBA will be forced to cut interest rates – which he sees going to 1% “if not lower”. This will help depreciate the currency even further.

From its current level of around US 74 cents, Gor reportedly thinks a forecast of US 50 cents is too optimistic, suggesting his base case is now closer to US 40 cents – roughly 46% below today’s level.

It’s important to note that the Australian dollar has already fallen remarkably from its high levels, when it was trading above parity with the US greenback for some time. I believe there could still be more declines to come – perhaps into the US 60s range – but a fall to US 40 cents does seem unlikely, in my opinion.

In saying that, there is certainly a case to argue that the Australian dollar is still overvalued. Further interest rate cuts locally are a possibility while the US Federal Reserve has been very vocal about its intentions to gradually increase its own interest rates when the time is right. A combination of those factors could certainly force the dollar lower.

As such, investors should consider positioning their portfolios to benefit if that does occur. I have personally invested in some US-based companies such as Facebook and, which is one way to potentially benefit.

Meanwhile, others are more comfortable buying shares in local companies such as Westfield Corp Ltd (ASX: WFD), ResMed Inc. (CHESS) (ASX: RMD) and CSL Limited (ASX: CSL), which generate a lot of their earnings overseas. As they repatriate their earnings to Australia, the exchange rate helps boost their returns in terms of Australian dollars, while investors can buy their shares via the ASX without having to open international brokerage accounts.

Of course, there are plenty of other great ways to make a profit in this market other than by relying on a weaker Australian dollar...

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The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and Facebook. Motley Fool contributor Ryan Newman owns shares of and Facebook. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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