© Neal Jennings, Reproduced under CC licensing
- AUD forecasts cut at CBA, recovery scrapped, as headwinds mount.
- Trade war hurts commodity prices, AUD, CNY and Chinese demand.
- Stronger for longer USD to weigh on AUD/USD, along with RBA cuts.
- AUDUSD slips into year-end before only shallow upturn late in 2020.
- But GBP/AUD set for slow, steady grind lower amid Brexit uncertainty.
Commonwealth Bank of Australia (CBA) has released new forecasts that show the Sydney-based lender no longer expects the Australian Dollar to recover into year-end.
Previous forecasts suggested Australia's Dollar was due to catch a break in the final quarter of 2019 as the Federal Reserve (Fed) began to cut its interest rate in earnest, enabling other currencies to draw capital away from the mighty and still-dominant greenback, but all of that changed with the August escalation of the U.S-China trade war.
President Donald Trump is expected to begin applying a 10% tariff to all China's U.S.-bound exports not covered by a punitive levy, although the process won't be completed until December 15, an outcome that is likely to see the Aussie Dollar remain under pressure.
This has further stoked already-elevated concerns for the Chinese economy and, in turn, the global economic outlook. The trade relationship explains the correlation between the Aussie and China's Renminbi, as well as why investors tend to view the former as a proxy for the latter. CBA says the Renminbi is likely to weaken even further up ahead, which is one of the reasons they've scrapped their projection for an imminent upturn by the Australian Dollar.
"The Chinese economy is now growing at a slower rate because of a slowing in [the] domestic economy, and because of the impact of U.S. tariffs on exports to the U.S.," says Richard Grace, head of FX strategy at CBA. "USD/CNH has been on an upward trend since the tariffs were first implemented. A further increase in tariffs, or other trade restrictive measures, will generate further upside in USD/CNH beyond our forecasts."
Above: AUD/USD rate shown at 4-hour intervals, alongside USD/CNH rate (green line, left axis).
With a retaliation against the new U.S. tariffs almost inevitable and the prospect of a descent into all-out global economic conflict ever present, markets are now betting the Reserve Bank of Australia (RBA) will cut its interest rate on two more occasions this year, even after minutes from the latest policy meeting suggested this week that it would like to see an "accumulation of evidence" suggesting further assistance for the economy is necessary before acting again.
The RBA has already cut rates twice in 2019, taking the cash rate down to a new record low of 1% and wounding the Aussie in the process, but China is Australia's largest trade partner and raw materials sold to it are Australia's largest exports. Demand for those exports could now suffer, at a time when the prices of raw materials are falling due to the deteriorating global growth outlook.
"Our previously published end‑September 2019 forecast of AUD/USD at 0.6800 remains unchanged. But we have lowered our year‑end forecast from 0.7200 to 0.6700 because of the stronger USD, the downward revisions to global economic growth, and because we now expect the RBA to deliver two more interest rate cuts. One in November 2019 and another February 2020," Grace writes, in a forecast note this week. "Our end‑period low point for AUD/USD is 0.6600 by March 2020."
Above: CBA graph of AUD/USD rate alongside 'terms of trade' and AU-U.S. bond yield 'spread'.
Reserve Bank of Australia board members decided to leave the cash rate unchanged at 1% earlier this month due mainly to uncertainty over the impact that an earlier two cuts would have on the outlook for the economy and inflation, minutes of the meeting revealed this week. There was also hope on the board that tax cuts announced earlier this year will aid the economy, although some members were concerned those funds would simply end up in savings accounts given the deteriorating growth outlook.
After cutting the cash rate from 1.5% earlier this year, policymakers agreed in August they'd like to see an “accumulation of additional evidence” before acting again and markets are now coalescing around the idea of a third 2019 cut coming in October. The market implied RBA cash rate for December 03, the bank's last meeting of 2019, was around 0.60% Wednesday and still indicative of an expectation among investors in general for two more cuts this year.
"The main risks to the updated AUD/USD forecasts are to the downside. This is because the downturn in global economic activity could be larger than expected, Australia’s terms of trade could decline more than expected, China’s exchange rate could depreciate more than forecast, and the RBA may have to resort to quantitative easing if a global economic shock eventuates," Grace says.
Above: AUD/USD rate shown at daily intervals, alongside USD/CNH rate (green line, left axis).
RBA Governor Philip Lowe and the board resorted this year to cutting the cash rate in in the hope of seeing the consumer price index rise back above the lower boundary of the 2%-to-3% inflation target. Austrlian inflation has been below the target level for much of the last five years or more, although the RBA's task has recently been made more difficult by an ongoing slowdown in both the domestic and global economies, which is partly the result of the U.S.-China trade war.
Changes in rates are normally only made in response to movements in inflation, which is sensitive to GDP growth, but impact currencies because capital flows tend to move in the direction of the most advantageous or improving returns. Those flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency.
"We have made significant downward revisions to our GBP/USD forecasts. We now project GBP/USD to trade closer to 1.1900 by year‑end instead of 1.2800 because of UK political and Brexit‑related uncertainties are elevated ahead of the 31 October 2019 Brexit deadline. We place a low probability (20% likelihood) that a new Withdrawal Agreement between the UK and EU can be reached over the next two months," Grace says.
Above: Pound-to-Australian-Dollar rate shown at daily intervals.
The Pound has fallen relentlessly against the U.S. and Australian Dollars for months now as the spectre of a World Trade Organization (WTO) relationship with the EU has been perceived as steadily becoming more likely, due mainly to broad opposition across the country and in parliament to the EU withdrawal agreement struck by now-former Prime Minister Theresa May and because of political infighting in Westminster.
Opposition MPs and even some lawmakers on the government's own benches are now conspiring in order to prevent a 'no deal' Brexit on October 31, which the current government says must happen if the EU refuses to open fresh exit talks with the newly-installed Prime Minister Boris Johnson. Speculation about an administration of 'national unity' has been building since early last Thursday, although the various proposed lineups have been overwhelmingly dominated by MPs from one particular side of the Brexit divide and the various factions of anti-Brexit MPs are yet to agree on who will lead such a government.
"Johnson has made it clear that the Irish backstop must be abolished for Brexit to proceed. This is unacceptable to the EU unless an agreement can be made that presents something similar," Grace says. "The risk of a hard‑Brexit (30% likelihood) or new General Elections (50% likelihood) are higher. The perceived probability of a no‑deal Brexit has risen markedly since May. Meanwhile, new General Elections will most likely require an extension of the Article 50 deadline, and prolong the political uncertainty."
Grace and the CBA team forecast the Pound-to-Australian-Dollar rate will drift lower from 1.7870 to 1.7761 by year-end, before declining to 1.7571 by the end of 2020. However, the Aussie is tipped to weaken relative to the U.S. Dollar, with the AUD/USD rate declining from 0.6780 to 0.6700 by year-end and falling further, to 0.66, in time for March 2020. The Aussie is forecast to end next year at 0.70, which is where CBA originally projected it would close the current year.
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