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Potential Triggers to an Australian Dollar Recovery

Australian Dollar

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- AUD stronger this week but still nursing large 2018 loss

- Traders await signal for a turnaround

- Inflation data and USD's performance could be key

The Australian Dollar has sold off extensively in 2018, falling between 6% and 8% against its major counterparts - now some analysts are saying the declines have been so hefty the currency may be bottoming.   

But forming a bottom is one thing - starting a new trend higher is quite another.

Analysts at Thomson Reuters are saying that for them to adopt a more bullish stance they would first need to see a fundamental "catalyst" which could kick-start a new trend higher for AUD.

The Aussie did, in fact, rise after strong employment data on Wednesday which showed the unemployment rate falling to 5.0% in September from 5.3% previously - a sizeable 3 basis point drop.

Yet the rise was not sufficient to turn AUD/USD's fortunes full-circle, and whilst some of the restraint was put down to Reserve Bank of Australia's (RBA's) Guy Debelle saying that a fall below 5.0% was probably necessary to get wage inflation rising, it also suggests strength in Aussie domestic data alone may not be enough to start a new rally.

"AUD/USD bounced back from Fed-induced losses with the help of strong Australian data, but it needs some help from the U.S. Dollar side of the equation if it's going to seriously extend these gains," said Christopher Romano, an analyst at Thomson Reuters.

An outside catalyst for an Aussie Dollar revival may yet come in form of a weakening US Dollar.

Economists are increasingly viewing the US's rising budget deficit with dismay. Figures out on Monday showed Trump's spending spree is likely to leave the US Treasury -$779bn out of pocket in 2018 - a six-year high and well above the -$666bn of 2017.

Economists at Wells Fargo are forecasting the deficit to widen to -1tr by 2019.

The cost of servicing the country's rising debt pile, meanwhile, is the Treasury's fastest rising cost at 24%.

Notwithstanding the outstanding performance of corporate America, particularly in 'tech', these cannot be strong fundamentals in any sense of the word, and eventually, they are likely to catch up with the Dollar.

These are not the only arguments for expecting the Dollar to fall.

Analysts at Nordea Markets believe the Dollar is set to fall when the US re-touches its debt ceiling in mid-November, especially, if Congress fights government demands that it be raised. A possible stand-off will force the Treasury to 'flush the system' with its 3-400bn of reserves creating a short-term buck-glut which will weaken the currency.

Other outside catalysts are looking more mixed for the Australian Dollar.

Chinese growth is slipping according to recent data and whilst this is not the first time we have heard false hard-landing warnings from China analysts (they have occurred with the frequency of Aesop's boy who cried wolf) it does appear the longer-term trend is gently cambering lower.

This time there is a key difference too - on previous hard-landing warnings China was not in a trade war with the US.

It is also true that People's Bank of China (Pboc) has been reassuring investors it is going to be there to offer support during the downturn, and this appears to have reassured Australian Dollar traders enough for them to buy after Beijing's last announcement.

The Pboc has also been busy defending its currency - a factor supportive of the Aussie. China is Australia's largest export destination and a strong Yuan is good for Australian exporters because it makes their goods more affordable to Chinese buyers.

Finally, news that there may be a light at the end of the tunnel for China-US trade talks ahead of Trump's mid-terms, could further support AUD. Trump may be in more of a mood to broker a deal with President Xi due to political pressure from his voter strongholds. China cleverly targeted its harshest tit-for-tat tariffs at areas in the US where Trump gets a lot of votes. Soybean growers being one example.

According to some analysts, this could be an incentive for the president to offer China an olive branch. If so it will be a bonus for the Aussie which has been especially sensitive to recent trade war headlines.

Not all analysts see the Australian Dollar as at the mercy of external factors. Derek Halpenny, European head of global markets research at MUFG, thinks the next important catalyst for the currency will probably be inflation data for Q3 on October 31.

"AUD could extend gains if CPI surprises.." says Halpenny.

A higher inflation rate will lift moribund expectations of the RBA raising interest rates again. Higher interest rates would be positive for AUD as they help retain capital flows. Currently, the RBA is not expected to raise rates until 2020.

Given the US is expecting to lift rates 3 or maybe even 4 times in 2019 alone, and even the European Central Bank is penciling a rate rise in September '19, the Aussie doesn't look very competitive from a comparative interest rate perspective - which is a major driver of FX.

Shorter-term, however, the evidence is starting to add up that the currency looks oversold, and therefore, due a bounce. The speculative futures market is showing an excessive number of bearish bets on the Aussie, which is often interpreted as a contrarian signal the currency will actually rise.

The question may be whether a bounce will turn into anything more. A lot may depend on the trajectory of the Dollar and whether Dollar-doomsayers like Nordea are accurate in their forecasts.  On the home front, the key release could be inflation on the 31st.

The question may be whether it provides the life-giving elixir AUD needs for a longer-term revival, or the poison that cuts dead a brief recovery.

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