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Australian Dollar Seen Headed to 2008 Low as Outlook Sours

Image © Desiree Caplas, Adobe Stock

- AUD wounded after RBNZ cuts deeply, iron ore capitulates.

- Market eyes RBA as others look to cut, trade war simmers.

- ING Group says risks are to the downside in weeks ahead.

- Commerzbank technical analyst sees AUD hitting 2008 low.

The Australial Dollar was badly wounded during the Wednesday trading session after an aggressive interest rate cut in New Zealand prompted markets to speculate the Reserve Bank of Australia (RBA) could soon follow suit, with price action prompting one influential analysts to warn the Aussie is in danger of falling back to its 2008 low. 

Multiple analysts were predicting further losses ahead for the Australian Dollar Wednesday after the Reserve Bank of New Zealand (RBNZ) slashed its cash rate by 50 basis points to a new record low of 1%, when markets had anticipated only a 0.25% cut.

More cuts are expected too given a deterioration in the outlook for the Kiwi economy, with expectations for growth being crimped by tensions between the U.S. and China as well as a slowdown in the broader global economy. This could pressure the RBA to follow suit.

"AUD/USD was dragged lower overnight by the broad‑based decline in NZD. The RBNZ’s 50bps cash rate cut increased the risks the RBA delivers more policy easing, and weighed on AUD/USD," says Elias Hadddad at Commonwealth Bank of Australia (CBA). "Lower iron ore future prices also undermined AUD/USD."

Above: Cfr 62% iron ore futures price at 4-hour intervals, and AUD/USD rate (orange line, left axis).

Iron ore had been on a tear going into the July month as supply outages in Brazil and demand from China boosted the value of the raw material, which is a significant item in Australia's export basket, before reaching a five-year high that month and then entering a period of consolidation.

However, prices have come back down to earth in August as demand from China falls in response to weakening steel prices. Falls in the iron ore price could have an impact on business investment and employment in the mining sector so they may well get the attention of the RBA. 

"Both currencies, the Australian dollar and the New Zealand dollar, are likely to remain the most prominent victims (G10 FX) of the global trend towards a looser monetary policy in the coming months," says Marc Andre-Fongern, a strategist at MAF Global Forex.

The RBA left its cash rate, which is now equal to the RBNZ rate, unchanged this week but told markets that it would cut rates if the outlook warrants it over the coming months. It's already reduced Australian borrowing costs twice this year, with the cash rate down at 1%, from 1.5% back in May. 

Financial markets were betting on Wednesday the RBA cash rate would be 0.55% on December 03, the day of the bank's final meeting for 2019, down from 0.60% on Tuesday. This suggests investors think the RBNZ rate decision has improved the odds of two more Australian rate cuts coming this year. 

The RBA has been attempting to the stimulate the economy with "accomodative" rates for years now in the hope that faster growth will take inflation back within the 2%-to-3% target band. However, international developments have increasingly turned against the Australian economy of late. 

Above: AUD/USD rate at daily intervals, alongside Pound-to-Aussie rate (orange line, left axis).

"Much will depend on the developments in the US-China trade war and in particular on how the tensions will impact Chinese economic data. But, for the time being, the balance of risks for the Aussie dollar remains heavily tilted to the downside," says Francesco Pesole at ING. "While we do not expect AUD/USD to trade far from our 0.68 forecast at the end of Q3, we acknowledge a sizeable risk of the pair moving below 0.67 in the coming weeks." 

China's economy is struggling and its currency is in decline due to another escalation of the trade war with the U.S., which entered a new phase this month when President Donald Trump said the country's remaining $300 bn of annual exports to the U.S. would be subject to a 10% tariff from September 01. It's other $250 bn of annual trade is already under a 25% levy, which Trump has threatened multiple times to impose on all of China's exports. 

Those tariffs have slowed the rate of economic growth and encouraged the People's Bank of China (PBOC) to allow the Renminbi, with which the Aussie is strongly correlated, to depreciate. Then PBOC set the midpoint of the USD/CNY trading band at 6.9996 Wednesday, close to the psychologically important 7.0 level and after fixing the rate at 6.9220 back on Monday. Some analysts say the USD/CNY rate could reach 7.50 this year, which implies more weakness for the Renminbi and Aussie Dollar ahead. 

Fundamental factors like the trade war and interest rates could well drag the Aussie lower over the rest of the year, although it's technical signals emanating from the charts that risk driving the AUD/USD to new losses over the short-term. And the those losses could be steep, according to Karen Jones, head of technical analysis at German lender Commerzbank. She's eyeing the prospect of a return to financial crisis era lows for the Aussie in the weeks ahead. 

"AUD/USD has eroded the .6738 January 2019 low and .6720, the 2016-2019 support line (connects the lows). This was decent support for the market and failure here suggests ongoing weakness to the 78.6% retracement at .6124 and the 2008 low at .6020. Rallies will need to regain the .6832 June low as an absolute minimum in order to alleviate immediate downside pressure," Jones writes, in a breifing to clients Wednesday. 

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