Australian Dollar Left Crippled after Chinese Industrial Sector Collapses

© Greg Brave, Adobe Stock

- AUD crippled Friday by dire set of Chinese economic figures.

- But G20 agreement holds as talks deescalate the 'trade war'.

- AUD budget to yield stimulus but only RBA hike can resuscitate AUD.

The Australian Dollar was left crippled Friday by official data that revealed a steep slump in actiivity within the Chinese industrial sector during November, which has dealt another blow to the Aussie outlook. 

It wasn't just industrial firms that saw fortunes turn for the worse in China during November as consumers also appear to have battened down the hatches. 

"China is once again the problem child of the global economy. Every weak figure causes many investors to sound the alarm bell, fearing a pronounced crisis in China and the resulting negative consequences for the global economy as a whole," says Jorg Kramer, chief economist at Commerzbank.

Industrial production growth fell to an annualised pace of 5.4% in November, from 5.9% previously, when markets had looked for it to hold at 5.9%.

Retail sales growth declined even further, coming in at just 8.1% for November, which marks a record low for spending growth among Chinese consumers.  

Growth in fixed asset investment picked up from 5.7% to an annualised 5.9%, in line with expectations and presumably because government splurged on infrastructure projects to support the economy during the period.

"The data certainly puts a further dent in recent optimism over the outlook for China that helped spark a rally in AUD/USD from close to 0.7000 toward the end of October to a high just below 0.7400 at the start of December. The 5.5% gain was fuelled in part by expectations that further China stimulus would help support economic growth," says Fritz Louw, a currency analyst at Japan's MUFG.

Chinese growth data is important for the Aussie because the Antipodean currency is underwritten by Australia's mammoth commodity trade with the world's second largest economy. This means whenever the Chinese economy or currency gets hurt, so too does the Australian Dollar.

Industrial production growth has now declined from 7.2% in February, the month before White House tariffs on Chinese steel and aluminium were announced, to less than 5.5%. Fixed asset investment has slowed from 7.9% and retail sales growth has fallen from an annualised pace of 9.7% in February.

It's exactly those figures that led markets to conclude this year that China's economy is heading for a rough patch, and it's the relationship between that country and Australia that explains the Antipodean currency's loss since July.

"Hope may act to support AUD at lower levels and today’s data may reinforce the resolve in China to support growth further. Markets will be watching closely the outcome of the Central Economic Work conference for policy announcements," says MUFG's Luow.

Above: AUD/USD rate shown at hourly intervals.

The AUD/USD rate was quoted -0.82% lower at 0.7162 Friday and is down -8.27% for the 2018 year, while the Pound-to-Australian-Dollar rate was 26% higher at 1.7561 and has risen 1.85% this year.

Above: Pound-to-Aussie rate shown at hourly intervals.

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'Trade War' Deescalation is Happening 

The Wall Street Journal reported Wednesday China is quietly working on a replacement of the Made in China 2025 programme in order to placate President Donald Trump and his administration.

That originally set out a vision for the world's second largest economy to dominate high-tech manufacturing fields over coming years, using a range of measures to get there.

"China's willingness to show flexibility on its Made in China 2025 policy is encouraging and perhaps not unexpected giving a slowing economy," says Richard Grace, chief currency strategist at Commonwealth Bank of Australia. 

Trump took issue with the way China used state funds to support commercial acquisitions of foreign technology firms and domestic laws in order to require foreign companies operating in the country to hand over their intellectual property to Chinese competitors.

The White House labelled that 'intellectual property theft' and 'unfair' trading. It responded with tariffs on $250 billion of Chinese goods imported into the U.S. each year and with demands for China to change. The Journal said Wednesday China is now drafting a replacement policy the U.S. will find less objectionable. 

"AUD got up to 0.7238 overnight before dipping back to 0.7210. Positive headlines have been rolling out of the China-US negotiations, suggesting it may squeeze higher in the short term. But bias is to sell rallies," says Daniel Been, head of FX strategy at Australia & New Zealand Banking Group (ANZ). 

Above: AUD/USD rate shown at daily intervals.

China has also pledged to cut tariffs on U.S. cars, according to the White House, and Bloomberg News reported Wednesday it's already begun buying larger amounts of U.S. soybeans in order to reduce the bilateral trade deficit.

Among other things, this suggests the 'trade war' detente agreed at November's G20 summit won't be disrupted by Canada's detention of a Chinese executive.

Canada's detention of Meng Wanzhou on charges relating to U.S. sanctions against Iran had roiled financial markets as some investors and analysts saw scope for the ensuing diplomatic spat to scupper the trade talks that have been key to a fragile peace in risk markets this December. 

This is all important for the Aussie because China is Australia's largest trading partner and so anything that hurts the Chinese economy could evenentually be felt in Canberra. Trade concerns explain much of the Aussie's loss since July.

"AUD has traded in a range around 0.72 since September. The consolidation has occurred as the Australia‑US 2 year bond spread has stabilised at around ‑80pts," says Joseph Capurso, another strategist at Commonwealth Bank.

American bond yields have fallen since the beginning of November as investors have begun to speculate the Federal Reserve might slow the pace of its interest rate rises next year which, as seen the difference between the two sets of borrowing costs become less disadvantageous to the Aussie. That has supported the currency.

Above: AUD/USD rate (red & blue) alongside 2-year AU-U.S. yield spread (roange)

Price action comes ahead of the latest government budget announcement on Monday, which some are suggesting could see a small stimulus package unveilled in order to lessen pressure on the economy and prop up electoral support for the government ahead of a general election due in 2019.

Any increase announced by the government would certainly not be a negative for the Australian Dollar, but economists at ANZ say markets have been anticipating a fall in government spending and that any changes would mean that fall simply becomes less of a weight on the economy over coming quarters.

As a result, it's unlikely to change policy at the Reserve Bank of Australia (RBA) so any resulting boost to the Aussie Dollar may prove to be limited.

"MYEFO is unlikely to change the Reserve Bank’s outlook, with the fiscal tightening already factored into the outlook. That may change as the election approaches and the parties reveal their policy intentions," says ANZ's Cherelle Murphy, in a note to clients Thursday. 

An eventual return to earlier highs for the Australian Dollar is still after all, contingent upon the RBA lifting its interest rate from the current record low of 1.5%, which would further close the negative gap between bond yields in the U.S. and those in the Antipodes. And expectations of an eventual rate hike have wained since third-quarter GDP data was unveilled just last week. 

Bank-beating exchange rates. Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here