Australian dollar caught between duelling forces

The foreign exchange market can place uneven emphasis on the factors influencing currencies at any given time.

In the Australian dollar’s case, it has been held back by its status as a proxy for Chinese growth as the world’s No. 2 economy faces a property sector downturn, a restrictive COVID-19 strategy, and broadly slowing growth.

BetaShares Capital’s David Bassanese warned that even if Chinese growth recovers from Beijing’s approach to controlling the coronavirus, officials seem intent on constraining steel production.

The volatility in equities and specifically, Wall Street entering a bear market, has also harmed the Aussie’s performance given it is generally sympathetic to perceptions of risk.

“In the short-term financial market uncertainty, concerns about Chinese GDP growth and less rate hikes than market expectations leads to a decline in $A. Next year there will be greater certainty about the interest rate path and this will see some appreciation of the $A,” said Peter Munckton from Bank of Queensland.

“And the US dollar is currently pretty overvalued,” he added, “the $A less so.”

The price of iron ore – the country’s top export – fell 4.3 per cent to $US113.90 a tonne in the spot market on Friday, according to Platts. Iron ore futures traded in Singapore fell 4.4 per cent to $US109.55 a tonne for the August contract. The $A was fetching about US68.06¢ on Monday.

“The $A/$US is as much as two standard errors below where we would expect it to be with export commodity prices this high,” said Michael Knox from Morgans.

“The major reason may be that Europe is very slow to tighten this cycle,” Mr Knox said, something that could mark the US dollar’s peak when the European Central Bank achieves lift-off.

Another factor that will work against the Australian dollar is the recalibration of Reserve Bank interest rate expectations as the more hawkish bond market catches up with economic consensus.

“As we move through the year we expect to see increasing evidence that the US economy is slowing in response to the policy steps taken by the Fed,” said ANZ’s David Plank.

“This should see the USD cycle turn and boost the AUD somewhat, though the unwinding of the excessive RBA rate hikes priced by the market should cap AUD strength,” Mr Plank said.

National Australia Bank’s Alan Oster said dips below the US70¢ level should be short-lived, all things being equal.

“Our base case is for the USD to start showing some weakness close to the end of the year, but before then the AUD is likely to continue to pivot around the US70¢ mark,” Mr Oster said.

“From a fundamental basis the AUD has solid support from a buoyant domestic economy and positive outlook for commodities, particularly bulk and energy.”

TD Securities’ Prashant Newnaha said the $A is a long-term beneficiary of a new world order.

“We are a politically stable nation and a credible supplier of the commodities the world needs. Stronger budgets and trade surpluses should also spur significant inflows into Australia for investment and reserve diversification.

“The drumbeat on the AUD heading to parity should begin to grow,” he added, with a two-year view in mind.

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