Australian Dollar Stunted by USD but Solid Fundamentals Underpin Outlook

- AUD slides as yields, USD rise ahead of 10-Yr auction.
- But fundamentals, valuation underpinning AUD outlook.
- RBA notes notes AUD not "overvalued" despite its rally.
- CBA tips AUD/USD at 0.81, GBP/AUD at 1.80 in 2021.

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  • GBP/AUD: spot rate at time of writing: 1.8035
  • Bank transfer rate (indicative guide): 1.7411-1.7537
  • FX specialist providers (indicative guide): 1.7771-1.7916
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The Australian Dollar languished near the bottom of the market's bucket Wednesday as the U.S. Dollar rose, although it's still a 2021 favourite with analysts and the outlook remains supported by solid fundamentals that were partly acknowledged by the Reserve Bank of Australia (RBA) mid-week. 

Australian Dollars were sold widely at the mid-week mark, leading to declines against all major currencies other than the Kiwi ahead of an auction of 10-year U.S. government bonds that some in the market have feared will lead to further increases in yields and potentially enable the U.S. Dollar to continue rallying. 

Losses were limited however, with AUD/USD down only -0.03% while other major currencies also softened in a manner that was indicative of a fleeting period of inertia that comes after global financial markets were upended by an international bond sell-off that had its roots in Washington.

The all-important auction is scheduled for 18:01 London time but before then the market will have to navigate February inflation data from the U.S., which will have implications for bonds and currencies. Wednesday's auction will also be followed on Thursday by a large sale of 30-year U.S. debt. 

"US 10 year Treasury yields rose with financial market participants waiting for the outcome of today’s US government auction," says Kim Mundy, a strategist at Commonwealth Bank of Australia, who forecasts AUD/USD at 0.80 in June and 0.81 by year-end. "Today’s CPI figures for February will gather market attention amid the reflation narrative. We are forecasting a lift in headline inflation because of higher gasoline prices. But core CPI likely remained muted."

"The U.S. Dollar has recently risen against all major currencies including an outperforming Pound Sterling, amid the pick-up in American bond yields although it's not yet clear whether these moves simply reflect profit-taking by investors on earlier wagers against the greenback that eventually resolves in further bets against it, or if this is the beginning of a more durable turnaround for the big Dollar. But either way the commodity-backed and higher-yielding Aussie remains a candidate for further 2021 gains. 

Above: AUD/USD at daily intervals with GBP/AUD (black line) and GBP/USD (yellow line). 

"RBA Governor Lowe this morning argued that the A$ is not currently overvalued – and we would agree. We have updated our short term fair value model," says Richard Franulovich, head of FX strategy at Westpac. "The revised model currently has the midpoint of fair value at 0.7860 with a range of 0.7580 to 0.8150. And even though the sharp drop in iron ore prices/ flattening of the A$ curve seen in the last couple of days will see fair value drop at the end of this week (if these moves are sustained), it is unlikely to see the A$ as overvalued."

Australia's Dollar has benefited not only from investor expectations of a global economic recovery later this year, which have already lifted all-important commodity prices and AUD/USD sharply, but also a domestic economy that is believed to have already recovered the output lost to coronavirus-related 'lockdown' last year. These factors have led the underlying and market perceived 'fair value' of the Aussie to rise alongside Australian exchange rates, meaning that despite already large gains, it's not yet "overvalued".

This sentiment was echoed by RBA Governor Philip Lowe overnight, who was reported to have said in response to a question at the AFR Business Summit that the bank "would be comfortable if AUD is lower still but won't say it is overvalued now." Lowe also reiterated the statement made by Assistant Governor Christopher Kent last month when acknowledging that RBA quantitative easing and other monetary policies have been "contributing to a lower exchange rate than otherwise." 

"We estimate fair value for AUD/USD is now in a range of 0.77 to 0.89, centred on 0.83," says Joseph Capurso, a CBA colleague of Mundy's in a recent review of the bank's forecasts, who looks for the Pound-to-Aussie rate to trade around 1.80 into year-end. "We have materially increased our forecasts for AUD/USD by up to 6 US cents.  The main reason for increasing our forecasts is the significant jump higher in commodity prices since our prior forecasts were published in November 2020."  

Above: U.S. 10-year and Australian 19-year (yellow) bond yields with 02-year AU (black) nd U.S. (purple) yields.