Australian Dollar Rallies Amidst Improved Market Optimism, but "Deep Recession" Forecast to Keep a Lid on Gains

- AUD rallies on improved market sentiment
- AUD outlook negative say CBA
- Westpac say AUD unemployment to spike 11%

Coronavirus Australia

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- GBP/AUD spot at time of writing: 1.9681
- Bank transfer rates (indicative): 1.8998-1.9136
- FX specialist transfer rates (indicative): 1.9300-1.9510 >> More information

The Australian Dollar advanced against a host of major currencies in the mid-week session, fuelled by an ongoing improvement in global market sentiment.

The Aussie currency tends to appreciate during times of global investor optimism which has been improving over the course of this week on the following:

1) The U.S, Federal Reserve announced an all-out effort to stabilise the U.S. and global financial system by committing to unlimited quantitative easing, as well as announcing a slew of other support measures.

2) The U.S. Congress overnight approved a substantial support package of $2TRN, which amounts to 9% of GDP, to aid the U.S. economy and households. "An unprecedented bout of stimulus is helping prop up global equities, with investors hoping to pick up some staple travel firms in the hope of a long-term recovery," says Joshua Mahony, Senior Market Analyst at IG. "We find ourselves in the midst of an unprecedented bout of global fiscal stimulus, there is plenty of good news helping to overshadow the inevitable economic difficulty that lies ahead."

3) China continues to normalise as it exits the grip of the disease. "Optimism returns in FX markets with high-beta AUD & NZD charging higher. Follows a green wave in Asian equities. News China is on the path to returning to some normality with Hubei province to remove travel bans tomorrow means Asia's COVID-19 economic cycle is close to a bottom," says Viraj Patel, FX and Macro Strategist at Arkera.

AUD outperforms

Above: The Australian Dollar's performance on March 25 puts it at the head of the pack

The Australian Dollar traded another 0.5% higher against the Pound, ensuring the Pound-to-Australian Dollar exchange rate has now fallen three days in succession to quote at 1.9575 at the time of writing.

The Australian Dollar has advanced a further 1.42% against the U.S. Dollar to quote at 0.6055 at the time of writing, ensuring four successive days of appreciation since bottoming at 0.5509 last week.

"Traders around the world dumped the USD in favour of other currencies, as the appetite improved for risk," says Besa Deda, Chief Economist at St. George Bank in Sydney.

The gains in the Aussie Dollar come despite warnings that Australia now faces a deep recession due to the coronavirus outbreak, confirming a potential tug of war over the currency between potentially improving global investor sentiment and a negative domestic outlook.

"We maintain that the risks to AUD are to the downside. A potential recession in Australia and in most of the large economies will bear down on commodity prices and AUD. Australia will implement more expansive shutdowns from tonight, further reducing economic activity," says Kim Mundy, a foreign exchange strategist at Commonwealth Bank of Australia (CBA).

Dire Forecasts for the Australian Economy

The negative impact of the coronavirus on the Australian economy is expected to be severe, with the outlook subject to further downgrades in the event that the government tightens its restrictions in an effort to curb the spread of the disease.

There are currently 2191 active Covid-19 cases in Australia, with 8 deaths recorded thus far. But experts at Australia's Group of Eight universities warn the number of cases could spike to 50K cases by Easter and back stricter social distancing measures to be enacted immediately as a result.

Covid in Australia

The further tightening of restrictions will in turn accelerate the economic contraction as more businesses close and movement of people is further curtailed.

"The COVID-19 shock to the Australian economy will trigger a deep recession and a sharp spike in the unemployment rate, jumping to 11% by mid-2020. The unfolding economic recession is shaping up to be more severe than the GFC," says Bill Evans, Chief Economist at Westpac.

Westpac forecast GDP to contract by 3.5% in the June quarter and do not expect a significant recovery until the December quarter.

The national unemployment rate is forecast to reach 11.1% by June due to a loss of 814,000 jobs.

"The COVID-19 outbreak is a medical shock. The key economic dynamic is the choice to shut-down and cancel events (a supply shock) in an attempt to limit the spread of the virus. Now, from late March, there are widespread shut-downs of places of social gathering (pubs, restaurants, gyms etc). These widespread disruptions to the economy are on a scale that we have not experienced in recent times – which has important implications for the labour market," says Evans.

How long it takes for the restrictions to be eased and life to return to normal remains highly uncertain and a staggered normalisation in activity is expected.

"When that happens, production will snap higher – returning towards earlier levels (although capacity will be impacted by the extent of bankruptcies) implying a period of sharp growth. For now, we anticipate that the shut-downs will essentially cease by the December quarter, with only a gradual relaxation during the September quarter," says Evans.

Westpac estimate the impact on the Australian federal budget will be severe, they forecast a deterioration in the budget from a balanced outcome for 2018/19 to a deficit of 4.5% of GDP ($90bn) for 2019/20 and then widening to a deficit of 8% of GDP ($160bn) for 2020/21.

This in turn requires the issuing of more government bonds by the government which would need to increase its borrowing to fund the deficit.

Westpac expect the supply of government securities on issue to increase by an additional $250bn to $820bn by June 2021 (40% of GDP), up from an actual of $542bn at June 2019.

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