Australian Dollar Pops but CBA and UBS Forecasts Spell Trouble

Image © Robyn Mac, Adobe Stock

- AUD lifted by fresh hopes of U.S.-China breakthrough. 

- But UBS says houses have -7% downside still to come.

- Correction to force RBA into action, possibly hitting AUD.

The Australian Dollar rose Thursday as markets cheered fresh signs the White House could be willing to extend trade negotiations with China past a March 01 deadline, although new forecasts from UBS and Commonwealth Bank of Australia (CBA) suggest things are already about as good as they'll get for the Antipodean currency. 

Bloomberg News reported Thursday that President Donald Trump is considering extending trade talks with China for another 60 days after the March 01 deadline that is currently scheduled to see U.S. tariffs on some imports from China more than double to 25%.

Thursday's report comes barely a day after Trump told his cabinet in the White House that he is open to the idea of extending the talks if there is a credible prospect of a deal to end the trade war being reached. 

"The 10 percent on $200 billion goes up to 25 percent on March 1st. And so far, I’ve said don’t do that. Now, if we’re close to a deal where we think we can make a real deal, and it’s going to get done, I could see myself letting that slide for a little while. But generally speaking, I’m not inclined to do that," Trump said

The South China Morning Post subsequently reported that President Xi Jingping will meet with U.S. Treasury Secretary Steve Mnuchin and negotiator Robert Lighthizer to participate personally in ongoing discussions. 

Both parties were repeatedly said this month to still be "worlds apart" on key issues like"coerced transfers of intellectual property" and state subsidisation of inustry. The White House says it will impose tariffs on all of China's $513 bn of U.S-bound annual exports if its "unfair trade practices" aren't abandoned.

Trump is already levying tariffs on $250 bn of Chinese goods imported into America each year, hurting the Chinese economy and the Australian Dollar, given the latter's close correlation with the Renmimbi. 

All of this matters for Australia because the Antipodean currency is underwritten to a substantial extent by a huge bilateral commodity trade with China, which could be hurt if the world's second largest economy goes on creaking under the weight of U.S. tariffs. 

Above: AUD/USD rate shown at daily intervals.

"Our AUD forecasts have been lowered slightly because the risk to Australia's economy have now become more evenly balanced. Previously there were upside risks," says Richard Grace, head of currency strategy at CBA. "The slowing global economy, and the risk of slower growth in household consumption as Australia's housing adjustment continues, will limit upside." 

The AUD/USD rate was quoted 0.21% higher at 0.7104 Thursday and is up 0.7% for 2019, while the Pound-to-Australian-Dollar rate was -0.43% lower at 1.8047 and has fallen by -0.29% this year. 

The Australian Dollar was higher against all G10 currencies for the session other than the Kiwi Dollar, which was boosted when the Reserve Bank of New Zealand (RBNZ) maintained its guidance that the next move in interest rates could be either "up or down" when markets had looked for it to warn that a cut could be in the pipeline.

Commonwealth is looking for the Aussie to rise back to 0.72 against the U.S. Dollar this year, and for the Pound-to-Aussie rate to fall back to 1.77. Those projections suggest only very limited upside for the Aussie this year, and are largely because of uncertainties about the economy and housing market.

Concerns about the housing market are growing among analysts and tremors in the real estate space have past form for jarring the Antipodean currency. 

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

"We remain cautious on the banks despite the share price correction and believe the risk of the current housing Credit Squeeze turning into a Credit Crunch is real and is rising," says Jonathan Mott, an equity analyst at UBS, in a recent note to clients. 

UBS economists say Australian GDP growth will fall to 2.3% in 2019 from in excess of 3% last year, and that the unemployment rate will rise to 5.2% before the Reserve Bank of Australia (RBA) cuts its interest rate in November. 

The housing market is at the heart of UBS' thesis, which matters to the Aussie given the negative wealth effects that falling prices can have on household spending. That is important for the GDP growth, inflation, interest rate and the currency outlooks.

UBS forecasts Australian house prices will fall by an additional 7% over the coming years, which would take total losses to -14% because prices have already declined by 7% so far. Prices in all of Australia's major cities are locked firmly into a downturn. 

Above: Australian residential real estate prices. Source: Commonwealth Bank of Australia.

"The UBS credit tightening thesis is playing out, with accelerating weakness in home prices, sales, approvals & credit growth," says George Tharenou, an economist at UBS, in note to clients earlier in February. "We have long expected a 10% drop, or more if regulators don't ease. But now that APRA has effectively ruled out further macroprudential easing, the risk of an even larger fall has increased."

Further housing deterioration is expected to result from regulatory measures and financial market developments that increasingly restrict the amount of credit available for mortgage borrowers, sapping demand from the market. 

The subsequent decline in growth and increase in unemployment is expected to force the RBA to cut its cash rate to 1.25% later in the year. Official data revealed on Tuesday a -6.1% fall in the number of new mortgages issued by high street lenders during December. 

Currency and interest rate markets are already priced for that rate cut to come before year-end so in itself such a move wouldn't necessarily do the Aussie any harm, but there's no telling what subsequent actions markets would begin preparing themselves for if the RBA went ahead and actually cut the cash rate. 

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