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Australian Dollar Likes News of Trade Deal Progress, but RBA Tipped to Lean on Significant Strength

Trade progress aids AUD higher

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- Markets eye potential December trade agreement

- Progress in trade talks being made

- AUD tracks fortunes of China's CNH currency and goes higher

- Yet domestic story could prove a barrier to sustained gains

Headlines detailing fresh progress in ongoing U.S.-China trade talks have bolstered the Australian Dollar, which is one of the better performing major currencies at the time of writing on Thursday, November 07.

And we are told that a decisive shift in sentiment on trade negotiations could well shift the Australian Dollar's outlook into upside territory, thereby bringing to an end a trend in depreciation seen thus far in 2019.

China’s Commerce Ministry have today said the U.S. and China had agreed to cancel existing tariffs in different phases. It said that if the ‘phase one’ deal is reached, both sides must cancel existing tariffs at the same time.

A spokesman for the Ministry said "top negotiators had serious, constructive discussions and agreed to remove the additional tariffs in phases as progress is made on the agreement."

Reuters report Presidents Xi and Trump could meet at the NATO summit in London on 3‑4 December.

The news adds to optimism that progress in the trade spat between the world's two largest economies is being made, and this has broader knock-on effects for the global economy.

Aussie Dollar performance today

Above: The Australian Dollar is outperforming the majority of its major counterparts today

The Australian economy, and its Dollar, are particularly exposed to news on the trade dispute, owing to the strong trade ties between Australia and China: in short, the trade dispute is hurting Chinese demand which has knock-on effects for Australian exports into China.

It is for this reason that the Australian Dollar has actually been mirroring moves in the Chinese Yuan (CNH) - which is the offshore and freely-traded version of China's Renminbi currency established in 2009.

"The 84% daily correlation between the CNH and AUD (relative to the USD) since the former’s inception is a reminder that another positive Chinese PMI or continued progress in U.S.-Sino trade talks could be all that is needed to revive the bulls’ hopes," says Neil Mellor, Senior Currency Strategist, BNY Mellon of the potential for a broader turn-around in fortunes for the Aussie Dollar.

The Australian-to-U.S. Dollar exchange rate has risen 0.3% to trade at 0.6903 pm the news, the Pound-to-Australian Dollar exchange rate has fallen to 1.8637 on the back of the Aussie's appreciation.

The below charts show us that the GBP/AUD exchange rate is in fact being driven by the Australian Dollar side of the pair, which is in turn being driven by moves in the Chinese Yuan.

GBPCNH

The above shows the strengthening of the Yuan against the Pound on the back of the trade news, the below shows the corresponding strengthening of the Australian Dollar against the Pound:

GBP to AUD

“Markets are showing themselves sensitive to the precise timing of the talks and risk of delay. But progress is apparently being made and hopes that there will be partial reversal in tariffs hikes is a clear positive for equity markets. We’ve had several false dawns on the trade war this year, but any agreement to start reversing prior to hikes, even in stages, is way more constructive than anything we’ve seen so far,” says Michael Metcalfe, Global Head of Macro Strategy, State Street Global Markets.

While there are headlines pertaining to the state of the trade negotiations on an almost daily basis, the feeling amongst the analyst community is that progress is certainly being made.

Neil Wilson, Chief Market Analyst at Markets.com says , "this is more of the same kind of pump we see almost daily. But it’s decidedly positive nonetheless."

Wilson says the question going forward from here is whether the White House would be prepared to ditch all tariffs in exchange for some vague commitments on agricultural products and IP and think it can sell that as a win to voters.

"However, the comments from the Chinese commerce ministry do indicate a path out of the mire," says Wilson.

Kit Juckes at Société Générale describes the trade negotiation headlines as an "image of dancers... because I can't escape the feeling that President Trump likes a ‘two-step forwards, one step backwards approach to negotiations."

"The erratic newsflow doesn't mean progress isn't being made - far from it. And in that regard some optimism is warranted," says Juckes. "Certainly, if a trade deal is struck, there's upside to both AUD/USD and AUD/NZD from here."

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Trade Progress Might Not be Enough to Turn the Aussie Around

While there is a striking correlation between the fortunes of China in the ongoing trade discussions and the Australian Dollar, investors should be aware that the domestic story does not yet bode well for a sustained recovery in the currency.

"Isn’t the latest news about as good as it gets on trade?" asks John Hardy, a currency strategist with Saxo Bank. "To get AUD pulling higher across the board and reasonably beyond 0.70-0.7100 here, we'll likely need a sense that the economy is on the mend Down Under and for key commodity prices to rise again."

BNY Mellon's Mellor agrees, saying that while the trade picture offers some potential upside for Australia's Dollar, the Reserve Bank of Australia (RBA) might be wary of a return to strength in their currency.

After all, a commodity exporter like Australia stands to benefit from a weaker currency as it cheapens the cost of Australian produce on the international market place and therefore stimulates demand potential.

There is a chance that the RBA sets policy conditions to lean against any unwanted strengthening of their currency.

"Are we to believe that the RBA is truly willing to provide the markets with the fuel to take on and breach the AUD’s year-to-date downtrend against the USD?" asks Mellor. "The RBA has proven to be one of the more candid central banks in airing its preferences for a weakening currency."

Mellor tells clients that until the Australia economy feels the benefit from improved global sentiment, or from recent interest rate cuts, "the RBA remains a major barrier to the scope for any sustained appreciation of the AUD."

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