FYI | Jul 13 2018
In an environment of increasing volatility and waning risk appetite the Australian dollar is unlikely to rally, while the US/China trade uncertainty is clouding the outlook for commodity prices.
-Risk sentiment likely to determine flows until late September as trade tariffs feature
-US earnings season may trigger volatility in US currency as guidance turns more pessimistic
-Widening interest-rate differentials with the US likely to depress Australian dollar
By Eva Brocklehurst
Supportive price action in the Australian dollar over recent days has been underpinned by a reduction in risk aversion, although analysts suspect this is unlikely to last.
Sentiment is rotating towards the US/China trade war, with a subsequent increase in volatility, while US economic data and Federal Reserve commentary remain to the fore and have reinforced a stronger trend in the US dollar.
AxiTrader's Greg McKenna believes the strength of the US economy and the fact President Trump appears to be cruising through his global meeting agenda are providing support for the greenback. Hence, the Australian dollar is likely to be sold on any rallies.ANZ analysts agree that any forthcoming weakness in the US dollar is likely to be contained, as data has started to perform better than consensus expectations.
Typically, the US dollar does not weaken extensively when global growth is weakening so, while catalysts for strength are becoming harder to find, the upshot is likely to be consolidation rather than outright weakness.
The analysts are also not convinced that any weakness in the US dollar will automatically provoke a rally in the Australian dollar, as risk sentiment should determine flows and is likely to feature until late in the September quarter.
Additional tariffs on China from the US are set to start in September and the analysts consider the Australian dollar a "sell on strength" currency.
Moreover, Morgan Stanley points out a global trade war and potential economic weakness means those currencies from countries with large current account surpluses are likely to gain, as weakness in risk assets prompts a repatriation of funds. In this case the Japanese yen is the natural candidate followed by the Swiss franc.
Conversely such an environment of declining global liquidity, rising volatility and waning risk appetite means currencies such as the Australian dollar are likely to underperform.
Volatility is likely to be heightened and investors in crowded positions should remain wary, Morgan Stanley suggests. Moreover, liquidity continues to deteriorate and this amplifies price action.
The upcoming US earnings season may provide a trigger as earnings guidance turns increasingly pessimistic in the wake of tariffs and slowing earnings growth.
Morgan Stanley also believes US growth is poised for a pullback, as almost half of the second quarter's GDP growth estimate is driven by inventory and trade, and this is likely to have been boosted by stockpiling ahead of the implement station of tariffs.
The high degree of foreign ownership of US assets suggests to Morgan Stanley that an initial safe-haven rally in the US dollar may be followed by weakness as these assets are liquidated.
There is also a risk that central banks, such as the Bank of Canada, may be tightening policy going into a weakening environment, which will be bearish for that currency as it plays out.
St.George analysts expect a great deal of uncertainty as fundamentals such as commodity prices and interest rates are not providing a clear picture for the direction of the Australian dollar. Also, the inclination for President Trump to backflip on policies underscores the uncertainty on the global stage.
Recent trade tensions have put pressure on some commodity prices, as this scenario implies downside risk to global growth, although most have held up reasonably well.
Over 2018 the relationship between commodity prices and the Australian dollar has broken down somewhat and St.George analysts believe the likely explanation is that financial market sentiment has renewed its focus on inflation and rising interest rates.
The widening interest-rate differential between Australia and the US, which has posed downside risk for some time, could be having more of an impact and dampening the Australian dollar, St.George analysts suspect. The US economy is performing relatively strongly versus others and this has propped up the US dollar.
The US Federal Reserve is expected to lift its funds rate further this year, while the Reserve Bank of Australia is not expected to lift official interest rates any time soon. Australia's unemployment rate has held within the range of 5.4-5.6% for 13 consecutive months and this suggests ongoing spare capacity within the labour market.
Financial markets have pushed out the timing for the first rate hike from the RBA and indicate little chance of one this year. The St.George analysts now expect the Australian dollar to end 2018 at US74c and 2019 at US76c.
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