RECENT ASSIGNMENT

RBA happy with Australian dollar but further falls expected in 2016
Mark Mulligan (2016), The Sydney Morning Herald, January 4, 2016
Mark Mulligan
Senior markets and economy writer
The Australian dollar has lost ground, but has also diverged from some of its usual drivers. Photo: Bloomberg
You can tell Reserve Bank of Australia governor Glenn Stevens is happy with how far the Australian dollar fell in 2015 by his silence.
For years a serial user of the -jawbone- technique of talking down the Aussie, Mr Stevens has been conspicuously quiet on the domestic currency for the last four months, despite its surprising resistance.
In August the RBA governor replaced the observation that -further depreciation seems both likely and necessary- in his monthly board meeting statement with -the Australian dollar is adjusting to the significant declines in key commodity prices-.
Foreign investor interest in Australian companies and financial assets has propped up the Aussie. Photo:
Westpac
Mr Stevens still appeared relaxed about the currency's relative value in his annual interview with The Australian Financial Review in December, when he broke with tradition and declined to nominate a new level.
-The answer to the question is the exchange rate has been adjusting – doing its job – and I note commodity prices are still falling, so it is possible that further adjustment will occur,- he said.
Despite a decline of almost 11 per cent against the US dollar in 2015, the Australian dollar has lost less than 7 per cent on a trade-weighted basis, which is an important measure of the country's global competitiveness as an exporter of goods such as iron ore and of services such as tourism and higher education.
Dollar up 5pc
According to this modelling, the Australian dollar could slip further in 2016 Photo: NAB
In fact, the Australian dollar has appreciated more than 5 per cent against the greenback since early September, at a time when iron ore – Australia's single biggest merchandise export – is trading at near multi-year lows of about $US42 a tonne.
The weaker a country's currency is against its trading partners, the more competitive its exports are and the more likely its residents are to take holidays at home and avoid expensive imports.
This fact has helped nurse Australia through the gradual decline in mining related investment and commodity prices since the end of the China-led resources boom in 2012.
But the recent disconnect has currency-watchers divided over why, and whether or not the Aussie will resume its gentle slide against the greenback once fundamental drivers kick back in.
They ascribe the Australian dollar's unorthodox behaviour to a range of factors, including buying by funds looking to hedge bets that it will continue to fall, a surge in Australian corporate and state bond buying by Japanese investors, merger and acquisition activity such as the $10.3 billion sale of the NSW electricity grid to a mainly foreign consortium, end-of-year book balancing and currency-hedging by Australian exporters, and market bets that the RBA has finished cutting the cash rate in the current cycle.
But CBA's chief currency strategist Richard Grace believes a further decline in Australia's terms of trade – which measures export prices against import costs – will drive down the Australian dollar against the greenback.
-That's why we've got further forecasts down in the exchange rate,- he said. -Because we think it will catch up to the terms of trade, which will continue to fall.-
Decline expected
The bank's official forecast remains for the Australian dollar to decline to US65¢ by the end of next year, although this is open to review after the US Federal Reserve's long-awaited decision in the middle of December to start lifting interest rates for the first time in almost a decade.
National Australia Bank said in late December it calculated the Australian dollar's -fair value- – where it should be according to conventional modelling – at about US67¢ or US68¢.
-Since the commodity price cycle peaked in 2011, significant valuation gaps – such as we saw in early 2013 and mid 2014 – have always resolved via a weaker currency,- the bank said in an outlook note.
-We look for history to repeat itself in 2016.-
Westpac's chief currency strategist Robert Rennie agrees orthodox drivers such as commodity prices and divergent central bank policies between Australia and the US, will ultimately pull the Australian dollar lower. But for now investor interest in Australian assets is holding the currency up.
-The picture we paint here is that demand for the Australian dollar is strong from non-traditional sources: realmoney investors including sovereign wealth funds, infrastructure funds and equity investors,- he said.
-However, our sense is the market is still too complacent on the Fed.
-The message the Fed gave us [in mid-December] is they fully expect to raise rates another four times in 2016.
-The potent combination of a stronger US dollar, higher rates in the US, weaker commodity prices, and increased risk aversion, will see [the] Australian dollar eventually fall below US70¢,- he said.
Read more: http://www.smh.com.au/business/markets/rba-happy-with-australian-dollar-but-further-falls-expectedin-2016-20151222-gltj6o.html#ixzz4CGcZTEmc
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Assignment
From the article titled ‘RBA happy with Australian dollar but further falls expected in 2016’ (Sydney Morning Herald January 04, 2016), answer the following questions.
(a) Briefly summarise the main issues discussed in this article? [Not exceeding 200 words] – (20 Marks)
(b) Using Demand and Supply model of exchange rate determination briefly explain how AUD is determined in the forex market, and what factors influence its fluctuations. – (20 Marks)
(c) Using exchange rate data from Reserve Bank of Australia and graphs (monthly data of last three years) analyse the movement of AUD relative to that of the US dollar? Is it in line with the world commodity price movement during this period? Are there any other factors contributing to this behaviour of the Australian dollar? – (25 Marks)
(d) Do you think that the AUD will fall as low as US 65C by the end of 2016? Justify your answer. What advantages do you think Australia will have in such a scenario? – (15 Marks)
(e) If the market rate is US 65C then what action could the Reserve Bank of Australia take in order to maintain the exchange rate at US 70C, and what side effects might this action have on the Australian economy? Do you think that such actions would be effective? – (20 Marks)
Word Limit: 2000 words maximum. Word count (excluding references) must be provided. Excess words will not be marked.
Instructions
1. This assignment is marked out of 100 and is worth 15 per cent of overall marks.
2. At least 4 relevant references are required regarding the issue featured in your allocated topic.
3. Turnitin Report: It will be compulsory for all students to submit the written assignment (final version) into the Turnitin system before submitting the hard copy to the tutor. Students are encouraged to submit drafts of the assignment before the due date, enabling students to check their referencing and rectify any issues before submission of the final version.
a. In the absence of the submission of the Turnitin report, a zero mark will be awarded for this assignment task.
b. A similarity index of less than 10 per cent is expected in your assignment. Zero tolerance applies for plagiarism
4. Hand in your hard copy of the assignment to the tutor on or before Week 8 of Trimester 3. Penalty applies for late submission.