FXStreet (Delhi) – Robin Winkler, Strategist at Deutsche Bank, suggests that the Australia is suffering from an income recession and the primary transmission channel for the terms-of-trade shock is mining investment, rather than net exports. Key Quotes “Only improvement in the external account, however, can prevent the income recession from feeding into a growing output gap and greater disinflation in 2016. That requires a substantially weaker exchange rate. We show that excessive imports are the main drag on output. The RBA hopes for rising domestic consumption ratios, but much additional spending will leak abroad and widen the trade deficit, in the absence of an improbably fast recovery in exports. At a time of declining investment and FDI inflows, we argue that Australia can ill afford to finance a widening current account deficit through debt-generating inflows. Reducing the output gap and unemployment through consumption therefore requires significant further depreciation so that import substitution stabilizes the external account. We estimate that a narrowing output gap with unemployment permanently at 5.9% requires the TWI to weaken by up to 10%, in line with fair value on our BEER model. This should also be the primary reflationary channel. On the bright side, Australian exports may not decline much further in USD terms. Large LNG volumes coming on stream from next year are mostly sold under long-term contracts and prices are sticky at current levels. Iron ore and coking coal prices should soon bottom out as non-traditional producers are forced to cut supply, permitting more resilient Australian miners to mitigate the price shock through growing export volumes. That said, risks remain skewed to the downside, and USD revenues are unlikely to recover as early as next year. The brunt of Australia’s adjustment therefore needs to come through the exchange rate. With CNY and EUR also forecast to weaken gradually next year, the required TWI adjustment implies more than 10% depreciation against USD and JPY. We lower our AUD/USD forecasts to 0.60 by end-2016 and 0.58 by end-2017.” ------- What will 2016 bring to the Forex traders? Attend our Forex Forecast 2016 - The Panel with Ashraf Laidi, Valeria Bednarik, Boris Schlossberg, Adam Button, Ivan Delgado and Dale Pinkert. Register for the live event on Dec. 18th and get the recording too. ------- For more information, read our latest forex news.