Australian Dollar Rally Looking Fragile: Westpac

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The Australian Dollar's outlook is "looking fragile" say analysts at Australian lender Westpac.

In a regular strategy briefing Westpac's Sean Callow in Sydney says fragility comes off the back of fragile commodity prices and "divided" Reserve Bank of Australia expectations.

"AUD/USD traded either side of 0.7000 over the past week, without looking likely to make a convincing breakout," says Callow. "Its weakest day was Tuesday, sliding a full cent. The initial catalyst was the RBA statement."

The Reserve Bank of Australia (RBA) raised interest rates by 50 basis points to 1.85%, as expected, but the Australian Dollar fell back on signs future hikes would be less aggressive.

It said future rate hikes were "not on a pre-set path" and that the economy would slow as a result of these hikes, leading investors to bet that 'peak' hawkishness had now passed.

"While delivering a third consecutive 50bp hike, the statement reference to policy not being on a pre path was enough to upset the hawks, A$ falling with yields. An awkward 38bp is now priced for the Sep RBA meeting," says Callow.

Elsewhere, Westpac notes commodity price support for the currency is mixed.

Australia derives significant wealth from the export of its abundant commodity reserves, particularly to China.

The value of these commodities surged following Russia's invasion of Ukraine, but commodity prices have trended lower since March.

Nevertheless, energy prices remain elevated and this could suit Australia's natural gas exporters.

"On the positive side, as the chart shows, soaring energy prices helped drive Australia’s trade surplus to a record high in June. But more recent commodity price action has been soft, as recession talk continues in much of the G7 and China is reportedly downplaying its 2022 growth target," says Callow.

The Australian Dollar does however find itself support by improved global investor sentiment at the time of writing on Thursday.

Two bellwethers of global investor sentiment, the S&P500 and Nasdaq equity indices, registered strong gains overnight rising by 1.6% and 2.6% respectively.

"The Australian and New Zealand dollars are benefitting from the ongoing rebound in global equity markets that extended further overnight," says Lee Hardman, Currency Analyst at MUFG.

The Australian Dollar is a pro-cyclical and 'risk on' currency that tends to advance when investor optimism is improving and global equity markets are rising.

This is particularly the case when there is a Chinese element to the drivers behind that improved sentiment, given New Zealand and Australia's close ties to the world second largest economy.

That China's bellicose response to Nancy Pelosi's Taiwan visit has culminated in 'war games' around Taiwan is offering some relief, with investors fretting earlier in the week that the response could have been more severe.

"The top performing G10 currencies have been the high beta commodity currencies of the Australian and New Zealand dollars as they continue to reverse losses from earlier in the week that were driven by the flare up in geopolitical tensions between the US and China over Taiwan," says Hardman.

Looking ahead, should investor sentiment continue its modest improvement the Australian Dollar would also be expected to see further gains.

The outlook remains challenging however, not least because the U.S. Federal Reserve is showing little inclination to end its interest rate hiking cycle.

The Fed will continue to force a slowdown in the U.S. economy until it is convinced it has turned the tide on inflation.

The reduction in global liquidity resulting from higher interest rates would in turn be expected to weigh on global economic activity.

Therefore bouts of weakness in markets and downturns in sentiment remain possible, which could pressure the high beta New Zealand Dollar.