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Chinese Stimulus Steadies the Australian Dollar but Analysts say Gains Won't Last

© Filipe Frazao, Adobe Stock

- AUD rises after PBOC injects stimulus into banking system. 

- But global stock market sell-off to keep AUD pressured say ING.

- J.P. Morgan forecasts more losses for AUD, NZD, cites technicals. 

Australia's Dollar steadied Tuesday after stimulus from the People's Bank of China (PBOC) helped stem an exodus from Chinese stocks and to stabilise the Renmimbi, but analysts say the Aussie will soon come under renewed pressure.

The PBOC cut the reserve ratio requirement for a range of large commercial banks by 1% Monday in the hope of encouraging new lending to businesses. 

It said the move will unlock as much as CNY 750 billion (£82 billion) for new lending while giving struggling banks a lifeline through which they can find the CNY 450 bn due for repayment to the central bank on October 15. 

This was significant because Australia's Dollar tracks the Chinese currency and stock market closely. And with the domestic economy motoring along at a steady pace while the Reserve Bank of Australia (RBA) sits on it hands, the Aussie has been taking cues from offshore events in for a while now. 

"The spillover effect to other CNY-sensitive currencies has been fairly limited; we usually view the AUD as a litmus test here and the currency is trading fairly neutral this morning," says Viraj Patel, an FX strategist at ING Group. "The stock market rout may keep high-beta FX under pressure." 

Above: AUD/USD with SSE Composite Index (black) overlay. Source: Netdania Markets.

"Whether it's a weaker Chinese yuan, sliding industrial commodity prices, rising US yields or waning risk sentiment - the external backdrop looks pretty bleak for the AUD. It's, therefore, no surprise that we've seen AUD/USD fall down towards 0.70," says Patel. "While we continue to see 0.72 as a short-term anchor point for the pair - the challenging external environment could see AUD/USD significantly and sustainably undershoot this level."

Australia's Dollar is underwritten by the nation's mammoth commodity trade with China and so it is sensitive to changes in sentiment toward the world's second largest economy as well as movements in raw materials prices, which are heavily influenced by expectations for global growth. 

The AUD/USD rate was quoted 0.05% higher at 0.7075 Tuesday, its second consecutive gain, but is down 9.2% so far in 2018. The Pound-to-Australian-Dollar rate was 0.29% lower at 1.8458 but has risen 7% this year.

This performance came after China's Shanghai Composite index posted a 0.17% gain for its Tuesday session while the Renmimbi stablised around the 6.92 level against the U.S. Dollar.

Above: Pound-to-Australian-Dollar rate shown at daily intervals.

China is President Donald Trump's first and foremost target in the so-called trade war he has launched in orde to bring down the U.S. trade deficit with other countries. 

Trump has imposed tariffs on more than $250 billion of Chinese goods imported into the U.S. each year and is threatening to target a further $260 billion. This could hurt Chinese exports to the rest of the world as well as growth in the world's second largest economy. 

"The already well developed downtrends in AUD/USD and in NZD/USD received an additional push via the latest down-reversal’s in leading risk markets like the S & P 500," says Thomas Anthonj, a strategist at J.P. Morgan. "We expect this down-consolidation to drag on for most of October, if not into November, before the classical year-end rally could unfold."

China's stock market has spent 2018 frontrunning the anticipated economic fallout and is now down by a total of 17.8% for the year-to-date. It fell 3.7% Monday alone.

Other stock markets appeared to have begun following suit last week, with the S&P 500 declining -1.45% to 2,882, although the nascent sell-off in the developed world may also have its roots in U.S. monetary policy.

Given the Australian Dollar and stock markets are so-called risk assets, which trade according to investors' appetites for risk taking, the Antipodean is exposed to the danger of a more protracted decline in global stocks. 

"It remains likely that key-supports at 0.7030 in AUD/USD and at 0.6450 in NZD/USD are broken, which would give room to challenge old lows from 2016/2015 at 0.6827 (AUD/USD) and at 0.6236 (NZD/USD)," says Anthonj, in a note to clients.  

ING's Patel has a one-month forecast for the AUD/USD rate of 0.70 while the technical strategy team at J.P. Morgan are warning clients that new multi-year lows are likely during the weeks ahead.

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