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Pound-to-Australian-Dollar Rate Outlook: Weakness Set to Persist

© Greg Brave, Adobe Stock

- AUD eyes potential Chinese tax cuts announcement this week.

- Fed could send USD lower and the AUD higher in week ahead.

- But Brexit to continue weighing on GBP until more clarity emerges.

The Australian Dollar set a new December low last week as international risk appetites waned but events in the global arena are now expected to provide breathing space to the Antipodean currency during the week ahead. 

Australia's Dollar had trended gently higher last week until dire Chinese economic figures sent it tumbling into the Friday close, although Sterling's own unique weakness meant the Pound-to-Aussie rate simply moved sideways. 

Looking ahead, the Aussie can rise over the coming days if the China story proves supportive. This is a busy week for the Communist Party, which celebrates 40 years of unprecedented economic growth under its leadership.

The China Daily reported government plans to unveil tax cuts that "could reach CNY1.5trn in 2019" at the Central Economic Work Conference this week.

If the market likes what it hears at the conference the Yuan could find support. This would in turn boost the Australian Dollar because it has a positive correlation with the Yuan.

Meanwhile, uncertainty about the path toward an orderly Brexit is expected to continue weighing on Pound Sterling, suggesting the best that the Pound-to-Australian-Dollar rate can hope for is another week of sideways movement.

"The risk of a no deal 'hard Brexit' remains a real possibility. GBP weakness will persist until UK politicians clarify the way forward. We expect no policy change from the Bank of England (BoE) following their meeting on Thursday," says Joseph Capurso, a currency strategist at Commonwealth Bank of Australia, in a note to clients.

Capurso and the Commonwealth team are waiting for angst over the Brexit process to drag Sterling lower again. They say the only way out of a gridlock that is drawing the UK closer to a so-called no deal Brexit from the EU is for government to hold another referendum asking voters how to proceed. 

Prime Minister Theresa May survived a leadership challenge last week but she still lacks enough support in parliament for her Brexit Withdrawal Agreement to make it onto the statute book. As a result, the probability of an exit from the EU on World Trade Organization terms could grow further still over coming weeks, weighing on the Pound. 

Appetites for Sterling are expected to remain low at a time when the outlook for the U.S. Dollar is turning for the worse, when hopes of a lasting de-escalation of the U.S.-China trade war are mounting and as markets are looking toward Thursday's labour market report from down under. 

All of this has the potential to keep UK bond yields under pressure and to weigh on U.S. yields, while lifting those of Australia's counterparts. The net effect of all that could be to drive the AUD/USD rate higher in the week ahead, and the Pound-to-Aussie rate lower. 

Above: GBP/AUD (red & blue) at daily intervals alongside AU-U.S. 2-year yield spread.

The Pound-to-Australian-Dollar rate was 0.38% higher at 1.7572 Monday and has now risen 1.91% this year.

The AUD/USD rate was quoted 0.01% higher at 0.7181 Monday but has now declined -8.27% for 2018 overall.

The orange line shown on the charts above and below represents the short-term bond yield differential or 'spread' for the two relevant currencies. 

The UK-Australia spread moved in favour of Sterling through much of 2018 but has lost influence over the exchange rate since early November as markets priced a further 'political risk premium' into British exchange rates. 

A reversal of the favourable spread movement could yet weigh on the Pound although the market might require further clarity around Brexit before it is willing to bid the Pound-to-Aussie rate higher in line with the spread.

The Australia-U.S. spread moved against the Aussie through much of 2018 before bottoming out in November. Data due over the next week will be key to where it and the AUD/USD rate move next.

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

The Federal Reserve is expected to raise its interest rate for a fourth time this year on Wednesday, taking it from 2.25% to 2.5%. 

This is widely expected by the market so investors will look to the FOMC's statement and economic projections for clues about the outlook. 

The decision and all of the usual economic forecasts will be released between 19:00 and 20:00 London time on Wednesday.

If the FOMC changes the language in its statement in a way that suggests policymakers are becoming more cautious about lifting U.S. rates then the market response would be bad for the Dollar. 

Likewise, if the so-called 'dot-plot' of FOMC members' projections for the Fed Funds rate reveals that some are feeling less hawkish than they did back in September then the market response would also be negative for the greenback. 

As much as the above scenarios have scope to dent the greenback, they could provide the Australian Dollar with some welcome respite because the currency has been crushed by the market impact of Fed policy this year. 

Above: 2-year Australian (red & blue) and U.S (orange) government bond yields in 2018. 

Fed rate hikes have lifted U.S. bond yields at a time when Australian yields have been under pressure, driving capital out of Australian financial markets while deterring new money away from them. 

The difference is marginal on the charts but short-term U.S. government bonds now pay investors more than their Australian counterparts.

This is because the Fed has raised rates while the Reserve Bank of Australia (RBA) has sat on its hands, with its own rate still at a record low of 1.5%.

But while the week ahead offers scope for U.S. yields to decline, it could also bring a pickup in Autralian yields too, if Thursday's labour market data reveals decent growth in Australian employment during November when the data is released at 12:30 am London time on Thursday morning.

Consensus is for jobs growth of 20,000 which, although down from a block-buster 32,000 in October, would still be regarded by analysts as a healthy reading. The unemployment rate is forecast to have remained steady at 5%.

"A strong labour market report, with the unemployment rate remaining at 5% (as expected), should temporarily help temper some of the downside associated with Australia's softening house prices. CBA Economics and consensus are looking for a 20,000 increase in Australia's employment growth," says Capurso.

 

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