2016 should mark the cyclical trough for AUD

2015 was another interesting year for the Australian dollar. For a start, AUD/USD reached its lowest level since 2009 in 3Q15. The range for the AUD in 2015 was one of the smaller seen in recent years, but continues the pattern of lower highs and lower lows observed over the past three years. For 2016, similar contours are expected for the AUD's trajectory; although the range is expected to be smaller than seen in previous years, that the pattern of lower lows and lower highs will be repeated. Generally the AUD is seen biased lower over the next 3-6 months on the back of modest softness in commodity prices and Fed tightening (1Q16 target ), before finding some support later in the year (4Q16 target ) as the terms of trade trough and the domestic economy gains enough traction such that RBA rate normalization is likely.

Thinking about what might be "new" for the AUD in 2016 relative to 2015, the outlook for commodity prices are the key differentiator in the year ahead. Australia's terms of trade have fallen 30% since 3Q11, acting as a compelling drag on the currency and nominal GDP in recent years. Indeed, economists are forecasting the terms of trade to decline 3.5% from 3Q15 through to 1Q16, and then for the terms of trade to rise 4.1% from 1Q16 through to 4Q16. This means that commodity prices will be more of a neutral for the AUD, relative to their influence in years past. 

Other factors which usually drive movement in AUD/USD are expected to be largely similar to 2015 - there should be further compression in short rate spreads (albeit driven by Fed tightening rather than RBA easing), and the ongoing slowdown in the Chinese economy is expected to continue, with growth likely to converge towards the mid 6s in the year ahead. But these dynamics are broadly similar to those which have prevailed in recent years, so don't add much new to the discussion around the outlook for AUD/USD. 

One implication of the view is that with 1) economists forecasting that the RBA has completed its easing cycle; 2) the large majority of the decline in commodity prices behind us; and 3) the slowing in Chinese growth ongoing but modest in magnitude, the currency is expected to mark its cyclical trough in 2016.