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Australian Dollar a Buy: Strategist

- NatWest are buyers of AUD
- Says terms of trade compelling
- AUD now best performer of past month
- Barclays warn of looming resistance to AUD gains

Australian Dollar outlook

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The Australian Dollar's recent trend of appreciation can extend says a strategist at a major UK investment bank, citing a solid backdrop of supportive stock markets and elevated global commodity prices.

In a recent strategy briefing to clients NatWest Markets say they are buyers of the Australian Dollar, expecting it to remain supported by a number of factors such as positioning, the country's trade balance dynamics and terms of trade shifts.

"A more neutral US rate picture also helps," says Paul Robson, Head of G10 Strategy at NatWest Markets.

The call comes as they exit a bet for Pound upside against the Euro, a position they have held for much of 2021 and one that has delivered profit thanks to GBP/EUR's ~6.0% advance already this year.

The Australian Dollar was one of the laggards heading into the mid-year period, succumbing to souring sentiment related to a Chinese economic slowdown and domestic Covid lockdowns.

But the lifting of domestic lockdowns and an improvement in global investor sentiment has allowed the Aussie to retrace losses and it is now the joint-best performing G10 major of the past month:

Aussie Dollar is joint best performer

NatWest says Australia's terms of trade have improved markedly of late and the trade surplus is now at a multi-decade high.

While Australia's export of iron ore has traditionally been the mainstay of the country's export basket, of late surging energy prices have placed a premium on the country's number two and three exports: coal and gas.

"China reportedly placed an unofficial ban on Australian coal imports and interestingly, there are reports that China might start importing Australian coal due to acute power shortages," says Robson.

But Robson also says a recovery in iron ore demand from a recent slump will further add to Australia's strong fundamental trade dynamics.

"Increase in overall commodity prices, and the recent pick-up in iron prices due to shutdowns in China is positive for AUD, as iron ore continues to be one of the largest exports and the recent ban by China does not include iron ore," he says.

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But trade dynamics are just one part of the Aussie Dollar's appreciation story: the currency's sensitivity to global investor sentiment is now providing support again.

The Australian Dollar is a pro-cyclical currency that tends to benefit when investors are in a positive mood and global markets are rising, a status which hobbled AUD during a turn lower in markets during September.

October has seen a recovery as investors appear to have made peace with higher interest rates at the U.S. Federal Reserve while also absorbing the reality that global growth has slowed.

Also helping sentiment is a view that the worst of the Covid-19 Delta surge has now passed.

Ashish Agrawal, strategist at Barclays Bank, says "a favourable risk backdrop could help AUD" over the coming days and he is looking for the Australian Dollar-U.S. Dollar exchange rate to retest resistance at approximately 0.7564.

This represents the 200-day moving average which is often used by technically minded traders as a key indicator:

Australian Dollar-U.S. Dollar

Above: AUD/USD daily chart with the 200-day moving average (blue line).

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Agrawal is looking for this area to provide the necessary resistance to perhaps deny the Australian Dollar further gains.

The 200 day MA also has significance for the Pound to Australian Dollar exchange rate, which is not a surprise given the overbearing influence of AUD/USD on all other Aussie Dollar cross exchange rates.

Like the headline AUD/USD rate, the 200 day MA is looming for GBP/AUD and could act as a potential level of support for the UK currency which has been sliding against its Australian rival since August:

Pound to Australian Dollar

Above: GBP/AUD daily with the 200-day moving average shown.

Pound Sterling Live's week ahead forecast for the Pound-Australian Dollar did note the 200-day MA as a potential support level, however our author did sense that the Pound was shaping up for a deeper decline on a longer-term multi-month timeframe.

"We expect bullish AUD momentum to stall and see risks of modest weakening in the coming weeks," says Agrawal.

In particular, Barclays look for the Reserve Bank of Australia to lean against market expectations of policy normalisation in the run up to its next policy review.

The market is currently pricing a first rate hike at the RBA for 2022, although the RBA is adamant that this is too soon and 2024 is a more realistic date.

But like other major central banks faced with the spectre of surging global inflation the RBA could be pushed into falling in line with market expectations.

This expectation is a source of support for the currency, therefore a determined RBA unwilling to deviate from its previous guidance could disappoint those betting on Aussie Dollar upside.

But Robson and his colleagues at NatWest anticipate the RBA to ultimately shift their stance.

"RBA remains one of the most dovish central banks in G10, adopting yield curve control and signalling a rate hike by 2024. We believe this ultra-dovish stance will soon be challenged due to higher inflation and possibly higher wages growth," says Robson.

They say the RBA's latest minutes - out last week - leaves clues of a possible sharp increase in wages and the members of the committee have not completely ruled out the likelihood of higher inflation in the periods ahead.

The bank’s liaison programme and other wages data indicated to the RBA that wages growth is likely to accelerate sharply in the periods ahead, which investors bet will prompt an earlier-than-signalled rate hike.

"We establish a new long AUD position versus an equal weighted basket of EUR and USD," says Robson.

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