Pound-Australian Dollar Rate Suffers Fresh Setback on Rocketing Aussie Yields

- Aussie ten-year yields put AUD on top
- Reflation story underpins AUD outlook
- J&J vaccine news gives global sentiment a boost

Aussie Dollar steams ahead

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Good news on the Johnson & Johnson vaccine, a jump in Aussie Bond yields and strong investor demand for commodities are conspiring to lift the Australian Dollar.

The rally in the broader Aussie Dollar comes at the same time Pound Sterling's 2021 rally takes a breather, resulting in a decline in the Pound-to-Australian Dollar exchange rate (GBP/AUD).

The Pound is seen by a number of analysts as trading above where it should be when fundamental considerations are made, meanwhile technical signals are suggesting some key GBP-based pairs are now looking oversold and some near-term consolidation is therefore likely.

As a result, the UK currency could find itself under near-term pressure against the Aussie and a decline from the month's high at 1.8022 could extend.

"The commodity-related currencies continue to benefit from building confidence in the outlook for the economic recovery. It has been notable that global activity data has continued to surprise to the upside at the start of this year in spite of the COVID-related restrictions that have been in place over the winter. It suggests that global economies have been adapting better than expected which is helping to dampen downside risks to growth," says Lee Hardman, Currency Analyst at MUFG.

Aussie is the best performer

Above: Over the course of the past year, the Australian Dollar has outperformed all its major peers.

The rally in global bond yields is proving to be of particular interest to investors at present, and a sharp rise in the yield paid on Australian government bonds has helped the Aussie Dollar higher say analysts.

"Australia’s 3-year government bond yields have proved not to be immune to the global reflation trade and have been trading above the RBA’s 0.1% target lately. Consequently, the RBA entered the bond market for the second time this week by buying a combined $A3BN of the April-2023 and April-2024 bonds," says Carol Kong, Associate International Economist and Currency Strategist at Commonwealth Bank of Australia.

Rising yields will attract inflows of international capital as investors seek out better returns, which in turn bids the Aussie Dollar higher.

However it is the yield paid on Australian bonds with a ten year duration - which are not targeted by the RBA's quantitative easing programme - that are arguably offering more support for the currency, as evidenced by the below:

Aussie tracks ising yields

Above: The Australian Dollar tracks a sharp rise in the yield paid on ten-year Australian bonds.

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"Australian-US 10-year bond yield differentials have widened considerably over the past week to over 30bp, proving some additional AUD/USD support," says Kong.

The rise in ten-year bond yields is a consequence of investors demanding a greater return for holding these bonds owing to a belief inflation will rise sharply over coming years.

This is a natural consequence of expectations for an improved global economic backdrop. That Australia's yields are rising faster than those elsewhere suggests expectations for potential Australian outperformance.

The Australian Dollar has risen against all its G10 rivals over the course of the past month thanks to a positive alignment of those factors that typically determine the currency's valuation, most notably the rising value of bulk commodities such as iron ore.

Improvements in global commodity demand has helped Bloomberg’s commodity price index to rise by almost 60% since April of last year, at the same time Australia's trade balance has seen its surplus widen as exports exceed imports. Australia's trade surplus stood at A$6.785BN in December, up from A$5.01BN in November.

An improving global backdrop owing to expectations for a vaccine-lead economic rebound is feeding into a stronger commodity complex, a widening trade surplus and ultimately the Aussie Dollar. "Elevated commodity prices are also AUD supportive," says Kong.

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"The outlook for a stronger global recovery has been supported by further positive vaccine news. The US FDA reported yesterday that Jonson & Johnson’s vaccine was effective at preventing severe COVID symptoms in the US, Brazil and South Africa. The findings of a report released yesterday revealed that the vaccine was 82% effective at preventing severe or critical disease at its trial site in South Africa, where the 501.V2 variant is prevalent," says Hardman.

The report said the vaccine showed 86% efficacy in participants in the U.S. and 88% in Brazil.

"It provides reassurance that current vaccines will continue to help reduce the risk of severe disease even from COVID mutations which will help to ease pressure on health systems and ultimately encourage the re-opening of the global economy," says Halpenny.

The J&J vaccine could be given its first emergency use authorisation in the U.S. as early as the weekend, however it is already being rolled out to the public in South Africa.

"Support from fiscal policy particularly in the US which will have positive spill-overs for the rest of the world is also set to receive a significant boost in the month ahead when the Biden administration is expected to pass through another sizeable stimulus package of around USD1.5-1.9 trillion," adds Hardman.

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