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Australian Dollar Pops on Fed Retreat but this Rally is Unustainable, Analysts Say  

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- AUD advances on G10 rivals following Fed interest rate retreat.

- But Westpac and UBS say rally  not sustainable, losses to resume.

- AUD/USD seen lower by both, but the two banks differ on GBP/AUD.

The Australian Dollar rose Thursday after the Federal Reserve admitted it might cut interest rates before the year is out and amid mounting hopes the U.S.-China trade war will be deescalated before the month is out, but analysts at Westpac and UBS are saying the Aussie rally is unsustainable.

America's Dollar slumped across the board Thursday in response to the latest monetary policy guidance from the Federal Reserve, which strongly suggested the central bank could cut its interest rate over the coming months, vindicating some analysts for having bet against the U.S. greenback.

This enabled the Aussie Dollar and all other currencies to rise against the U.S. Dollar, although the antipodean unit also scored gains over many of its other G10 rivals including Pound Sterling after the British unit lagged all its developed world counterparts in the advance against the greenback Thursday. 

But the move is destined to be short-lived according to analysts at Westpac, one of Australia's largest lenders, and UBS. Both banks have told clients either on Thursday, or earlier this week, that such action from the Federal Reserve will not be enough to keep the Aussie at its current levels. 

Above: Australian Dollar performance Vs G10 rivals. Source: Pound Sterling Live. 

"RBA easing frenzy to be overshadowed briefly by postFOMC USD slide and anticipation of Trump-Xi gladhanding," says Sean Callow, a strategist at Westpac. "Iron ore in $A terms is hitting highs since 2011 and gold is soaring. Positioning is already firmly short and confirmation of an “extended meeting” between Trump and Xi at the G20 should provide AUD some insulation."

The AUD/USD rate was 0.5% higher at 0.6915 during the Thursday session, it's highest level since early June and May. The AUD/USD rate has spent much of the second quarter below the 0.70 threshold and is still down 1.9% for 2019. The Pound-to-Aussie rate was 0.18% lower at 1.8357 but is up 1.14% this year. 

This bounce was due to the Federal Reserve's admission that it might cut U.S. borrowing costs later this year and, albeit to a lesser extent, optimism that both the U.S. and China will reach a deal at the Osaka G20 summit this month to end the trade war between the world's two largest economies. 

Those developments are positive for the global economic outlook, which the Australian Dollar and its commodity-centric economy are especially sensitive to, as well as for the difference between Aussie and American bond yields. 

"We switch our weekly bias from down to neutral AUD/USD given the above and likelihood that USD struggles for now. But risks still [tilt] back to 0.68 on a 1 month view," Callow writes, in a note to clients Thursday. 

Above: Westpac graph showing tide of money manager bets against AUD, alongside AUD/USD rate.

The Federal Reserve raised its interest rate four times in 2018, taking it up to 2.5%, which is the highest level in the developed world. That sucked investment capital out of economies across the globe and drew it toward the U.S., driving most currencies lower against the greenback in the process. 

Short-term speculators also piled into the U.S. Dollar last year, and bet against the Aussie, which helped drive the AUD/USD rate to an annual loss of nearly 10%. The Pound-to-Aussie rate also rose notably that year.

An expensive U.S. Dollar and high American rates lifted financing costs for everybody the world over and then the U.S.-China trade war started in earnest, hurting the global growth outlook and ensuring other currencies succumbed further to the overtures of a higher-yielding and safe-haven greenback. 

However, the trends of 2018 at least looked to be reversing on Thursday, with Fed guidance encouraging financial markets to bet it'll cut interest rates three times before the curtain closes on 2019 and with markets looking forward to the G20 meeting between Presidents Donald Trump and Xi Jingping. 

"We doubt the AUD can sustainably rally above 70 cents even if markets are right on Fed pricing. Fed cuts based on the risk of a protracted trade war and a global downturn are hardly positive for the AUD," warns Bhanu Baweja, deputy head of macro strategy at UBS, in a note to clients earlier this week.

UBS' Baweja says the Fed's Thursday guidance that it might cut U.S. interest rates this year is the result of concerns about the outlook for both U.S. and global economies, which have their roots in the U.S. trade war with China. 

Above: AUD/USD rate at daily intervals, alongside the Dollar Index (blue line, left axis).

The Fed itself did say, back in January when it first abandoned its earlier commitment to lifting U.S. interest rates, that it's concerns were mostly with the global economy outside of the U.S. A global growth slowdown would always be likely to come back and bite the U.S. economy in a boomerang fashion.

And the Aussie is highly sensitive to changes in the global growth outlook because it's underwritten largely by raw material exports to places like China, prices of which are also sensitive to expectations for global growth. 

This is why Baweja and the UBS team say the Australian Dollar rally cannot last, even if the Federal Reserve is cutting its interest rate. The Swiss bank is also concerned about the outlook for Reserve Bank of Australia (RBA) interest rates."

"Recent RBA communication suggests the Bank may intervene with further rate cuts to offset USD weakness," Baweja says. "We revise our forecasts for the AUD lower to 66 cents by end-19 and 70 cents by end-20. This largely reflects a more bullish outlook for the USD; but also heightened downside risks from the domestic macro and policy outlook."

Baweja and the UBS team forecast the Pound-to-Australian-Dollar rate will fall from 1.8356 Thursday to 1.7727 before the year is out, although this decline has very little to do with the Aussie and everything to do with an ongoing and so-far farcical Brexit process in the UK.

Westpac's also forecasts for the AUD/USD rate will fall all the way to the 0.66 level by the end of December, although the bank is targeting a move down to 0.68 over the next month. The Australian lender projects the Pound-to-Australian-Dollar rate will rise to 1.92 by year-end, based on the expectation of losses hitting the AUD/USD rate while the GBP/USD rate ends the year at 1.27.

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

 

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