The Australian Dollar is Forecast to Remain Supported by Improving Trade Fundamentals

- Aussie records another sizeable trade surplus
- Trade surplus tipped to improve country's current account balance
- Provides fundamental support to AUD valuations

Iron ore exports Australia

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Australia continues to earn more from international trade than it spends, confirming that a significant fundamental anchor for the currency exists that could result in further strength over coming weeks and months.

In seasonally adjusted terms, the balance on goods and services was a surplus of $8,025BN in May 2020, an increase of $195MN on the surplus in April 2020, reports the Australian Bureau of Statistics.

Australian trade balance

However, the surplus appears to be a result of a sharp fall in imports which were down 6.1% on the month, understandable given the coronavirus lockdowns which resulted in a sizeable hit to demand in the economy.

Export were also down, falling 4.3% with a slip in coal exports being particularly sizeable at -13.3%.

Nevertheless, economists at Commonwealth Bank of Australia expect Australia to post a large current account surplus of around 2¾% of GDP in the second quarter of 2020.

"Indeed, Australia’s improved current account position is one of the reasons we are expecting further AUD strength in the months to come," says CBA FX Strategist Kim Mundy.

The Australian-to-U.S. Dollar exchange rate is quoted 0.30% higher in the wake of the trade data at 0.6929 and the pair is looking to record a fourth consecutive day of gains.

The Pound-to-Australian Dollar exchange rate is quoted at 1.8037 at the time of writing, with the pair caught in a downtrend that we expect to extend, particularly if Australia's trade dynamics remain as supportive as they currently are.

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Analysts at Westpac point out that the Australian Dollar could be a factor behind the trade surplus actually coming in below economist expectations: the surplus of $8BN was less than the $9BN the market was expecting. "The exchange rate was a factor in weaker exports and imports in May, with prices lower due to the stronger currency. The Aussie rallied 3.4% against the US dollar (3.0% on a TWI basis)," says Andrew Hanlan, an economist with Westpac.

If this observation is shared by the Reserve Bank of Australia we could hear policy makers express concern over the currency's strong run since March, which could take some of the shine off the rally.

Regardless of any RBA jawboning, the overwhelming message from today's data is that Australian exports are providing a fundamental bedrock for the Aussie Dollar to rest on, and as we reflected in yesterday's piece, trade dynamics are only set for improvement.

Basic commodity prices, a critical component of Australian Dollar valuations, continue to improve thanks largely to increasing demand from China where the recovery is firmly on track.

"Exports to China were +8% month on month owing to the advanced stage of the recovery in the world's second-largest economy. "Overall, strong exports to China and soft import numbers are driving the firmer trade surpluses since the Covid outbreak and we expect more of the same next month," says Mark McCormick, Global Head of FX Strategy at TD Securities.

Iron ore prices remain elevated courtesy of Brazil's struggles to contain the coronavirus outbreak, keeping the risk of mine disruptions elevated.

Iron is Australia's main foreign currency earner and the hit to Brazilian production has gifted Aussie miners higher prices which should underpin the country's terms of trade which is a fundamental support for the currency.

Prices of iron ore are up 12% year to date according to Mysteel Global, "however many view a price over the $100/t as unsustainable," says John Meyer at brokers SP Angel, pointing at a potential paring back of the recent gains in iron, which could put a lid on Aussie Dollar performance.


Above: GBP/AUD daily chart

Coal is Australia's second largest export, and Chinese coking coal imports from Australia up 51% year-on-year according to Meyer, which suggests the drag presented by coal in the latest set of trade statistics should ease.

"Coking coal imports from Australia stood at 2.07mt in May vs 1.37mt the year before, and 4.47mt in April, according to customs data. Australia has taken market share from other exporters such as Mongolia, who are only now gradually resuming shipments to China after suspending them in early Feb to avoid the spread of coronavirus," says Meyer.

Further signs of the ongoing recovery for basic commodities is evident in copper dynamics where Chinese imports of refined copper increased 6.2% compared to April and 22.7% compared to May 2019, totalling 505,700 tonnes according to Chinese customs data.

Copper is significant in that investors tend to watch its performance when looking for turning points in the global economy, giving rise to the term "Doctor Copper".

"The rebound in the copper price, which hit multi-year lows when the coronavirus was at its peak in China, is now recovering due to the top consumer's rebound along with mounting supply concerns in South America," says Meyer.

GBPAUD forecast

The metal has surged 20% this quarter and climbed above $6,000/t last week for the first time since the COVID-19 outbreak became a global pandemic according to Bloomberg data.

Three-month copper contracts on the London Metals Exchange rose 0.6% this morning to $5,979/t according to Fastmarkets data.

On Monday, Shanghai copper prices hit their highest in more than five months according to Reuters data as traders feared a drop-in output in Chile due to a spike in COVID-19 infections.

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