Bank of America Merrill Lynch Global Research have released a report concerning their latest investor trip to Australia. They have told clients that Aussie is expected to be short-lived.

The Australian dollar exchange rate complex (AUD) has outperformed expectations since the start of April with the all-important AUD-USD rising from 0.7533 and leading many to question the entrenched long-term depreciation. Not even a second RBA interest rate cut could pressure the currency lower.

Nevertheless, the recent strength in the Aussie should however be not mistaken for a turn in fortunes say analysts at BofA who have confirmed their bearish stance on AUD-USD following the recent investor trip to Australia. Over the course of the trip analysts sought the views of onshore investors as to what the future holds for both the economy and the exchange rate.

“Our conversations suggested the overwhelming consensus was still negative on economic prospects for Australia, as well as the exchange rate. While investors were keen to hear our views on the US recovery, as well as its implications for Fed policy and the US dollar, our discussions on Australia focused primarily on country-specific drivers,” says Adarsh Sinha at BofA.

The BofA report points out that much of the climb in the Australian dollar owes itself to fundamental improvements in the domestic situation including RBA communication, Chinese easing, the budget, and speculative positioning

“Our bottom line is that a confluence of factors led to a squeeze higher in the AUD but most are likely to prove temporary,” says Sinha.

Gearing up for a Return to Weakness

According to BofA, Australian investors have not changed their view that the domestic fundamentals require a weaker exchange rate. They view the squeeze in the AUD as primarily related to temporary factors that we discuss in more detail below.

What surprised the team however was that most investors, when asked if they were short AUD in meaningful size, said they had pared back positions to small shorts or flat due to the recent price action.

“There were some exceptions such as some local real money investors that suggested they were still underhedged on their foreign investments and would probably have to increase hedge ratios (buy AUD) on any sizeable drop. But for the most part, positioning seemed much less of an obstacle to AUD depreciation than earlier this year,” says Sinha.

China Won’t Help, No Support from

Here are a couple of issues cited by Bank of America that will back their negative view on the Australian dollar’s outlook:

Onshore investors were not looking for China to come to Australia’s rescue. While most acknowledged China’s aggressive easing meant headline growth would stabilize over the next couple of quarters, there was little expectation that China’s commodity demand would strengthen materially as property construction remained outside the focus of easing measures.

It is the view of BofA that the most important driver of AUD depreciation was only just starting to transpire – specifically capital inflows into the resource sector, which had been the predominant source of funding for the current account deficit, had decelerated with net inflows already close to zero in 4Q 2014 (Chart of the Day).

“Our discussion with investors focused on whether there could be any other inflows that take up this slack – our view was probably not and there was little push back,” says Sinha.

Two reasons are cited: 1) the little rebalancing that is evident is predominantly in the service sector that has shown a rise in both exports and employment. However, the service sector is hardly capital intensive and unlikely to attractive sizeable foreign investment; 2) foreign purchases of Australian bonds remain large but is likely to diminish as global FX reserve growth slows and US yields rise.

Furthermore, any strength given to the AUD by the recent budget is also expected to be short-lived. BofA’s economists anticipate that any improvement in household sentiment will be limited in the face of a weak labour market and historically low wage growth.

“The government measures to encourage “small ticket” investment could be supportive of the retail sector but our economists doubt that it will be sufficient to have any material impact on overall economic activity. In this sense, any spillover to the AUD from the positive reception to the budget is likely to prove temporary,” says Sinha.