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- AUD on the slide in new week after U.S.-China tariffs implemented.
- AUD tipped to go lower in days ahead as the global backdrop sours.
- Nordea says sell AUD as the U.S. yield curve inversion is here to stay.
- RBA seen holding rates at 1% but teeing itself up for further rate cuts.
The Australian Dollar limped into the new week on its back foot Monday after President Donald Trump imposed more tariffs on U.S. imports of goods from China, prompting local analysts to warn of further losses in the days ahead and Nordea Markets to tip the Antipodean unit as a sell.
President Trump has imposed a 15% tariff on another $112 bn of goods imported from China each year, which takes the total value of Chinese exports now covered by punitive levies above $360 bn, although there's still a further $190 bn worth of tariffs scheduled to take effect on December 15. China has retaliated with a tariff of its own on around $75 bn of imports from the U.S., although its capacity to respond is constrained by the fact it has a significant trade surplus with the U.S.
"There was almost no further commentary from US President Trump on trade issues over the weekend as his administration is thoroughly distracted by the threat posed by major hurricane Dorian," says John Hardy, chief FX strategist at Saxo Bank. "One can only assume from the market action that the market remains hopeful of a détente or better and any headline discouraging that notion will likely prove very negative for risk sentiment."
Above: AUD/USD rate shown at hourly intervals, alongside GBP/AUD rate (aqua green, left axis).
The U.S. and China have been warring with tariffs and other policy tools over the latter's "unfair" trading practices since the first quarter of 2018 and with the White House facing an election year in 2020, it's under pressure to secure a victory and cannot afford to lose face in the conflict. Global trade, not to mention economic growth, has already fallen as a result of the uncertainty thrown up by the conflict but many now anticipate further weakness ahead.
And Australia's Dollar has been wounded by the tariff fight because it has a close correlation with China's Renminbi and is to a large extent underwritten by commodity exports to the world's second largest economy, prices of which risk being dented by the souring outlook for global growth. The U.S. economy has so-far been resilient in the face of slowing global growth but the bond market is now pointing to trouble ahead.
"The US 10y/2y yield curve has stopped playing around and has become a little more significantly inverted (-2bp) after last Friday's JH speech and China/US escalation. Based on the average of the past five major inversions over the past 40 years (1978, 1989, 1998, 2000 and 2005), the curve may stay inverted until mid-2020," says Martin Enlund, chief FX strategist at Nordea Markets. "An inverted curve is usually bad news for the Antipodean currencies (NZD, AUD)."
Enlund and the Nordea strategy team said Monday they are now sellers of the risk-sensitive Australian Dollar because bonds markets are continuing to suggest the U.S. economy is headed for a recession, which would be bad for the entire global economy but particularly resource-dependent economies like Australia and commodity backed currencies like the Aussie. Nordea says this should be positive for the safe-haven U.S. Dollar.
Above: U.S. Dollar Index alongside difference between U.S. 10 Yr and 2 Yr bond yields (left axis).
Two-year U.S. bond yields are now higher than their 10-year counterparts, making the 'yield curve' invert and leaving it with a downward sloping appearance that suggests the market sees rates being much lower in a few years time than they are this week.
Only a sudden and significant de-escalation of the trade war, or steep rate cuts from the Federal Reserve that disproportionately impact the yields of short-term bonds rather than long-term ones will be enough to reconstitute the message of the yield curve into one that's more favourable for the outlook.
"We open a short AUD/USD position (to reflect our positive USD view) with a target 0.6540," Enlund writes, in a note to clients. "Could the RBA have a surprise cut in store for us? Markets price in more than 40 bps worth of cuts for the rest of the year, but the bulk of the cut expectations are saved for October and November. We are not sure why the RBA should wait with cuts."
Nordea's rationale for selling the AUD/USD rate is mainly related to its bullish outlook for the U.S. Dollar but Enlund did flag on Monday, a risk that the Reserve Bank of Australia (RBA) surprises the market with a third 2019 interest rate cut during the early hours of Tuesday morning, The RBA is scheduled to announce its latest decisions at 05:30 London time Tuesday and economists as well as investors are substantially all looking for it to leave the Aussie benchmark of borrowing costs unchanged at 1%.
Above: AUD/USD rate shown at daily intervals, alongside GBP/AUD rate (aqua green, left axis).
"Why not surprise cut already this week, instead of waiting for the inevitable increase in unemployment before cutting? Maybe the RBA learned a trick or two from the recent RBNZ policy decision? We like to be short AUD in to the meeting and have added a short AUD/USD position accordingly," Enlund says.
The RBA itself hinted last week that it would like to see an “accumulation of additional evidence” that more stimulus is necessary before acting again and markets are now coalescing around the idea of a third 2019 cut coming in October. But with the trade war escalating again this week and the RBA itself long having been concerned about the impact it might have on Australia's already-struggling economy, a surprise cut cannot be ruled out for Tuesday.
The RBA cut the cash rate by 25 basis in both June and July, leaving it at 1%, in an effort to lift inflation by stimulating the economy with lower borrowing costs. 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 seek out the most advantageous or improving returns.
"AUD/USD has opened up Monday morning trade weaker and will remain under downward pressure this week. The deteriorating global economic outlook and US-China trade tensions are major headwinds to AUD/USD," says Richard Grace, chief currency strategist at Commonwealth Bank of Australia. "Australian local influences should guide AUD/USD lower this week. While we do not expect the RBA to cut the cash rate on Tuesday, we expect the RBA’s post-meeting statement to remain cautious."
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