Australian Dollar's Artificial Support Will Fade Say Westpac

Westpac say the Australian dollar exchange rate complex (AUD) has been propped up by a number of events that they expect to be temporary.

Most analysts we follow expect the AUD to fall through the end of 2015 - hardly a surprising revelation considering the well documented slowdown in Australia's mining sector and the small cold caught by the Chinese economy.

What is more interesting to us though are those bouts of Australian dollar strength when placed within the context of AUD negativity and whether we can expect more of the same over coming months.

While Chinese markets continue to buffer the commodity dollar complex there is the sense that the AUD should be doing a lot worse than it is.

"AUD/USD was somewhat less sensitive to global fears about China’s economic slowdown as the Aussie is first in line when traders price in the consequences of a weaker growth from the world’s second biggest economy," says Arnaud Masset from Swissquote Research.

However, there are certain market forces that are preventing the AUD from dropping near term.

Robert Rennie, Global Head of Market Strategy at Westpac, tells us why the Australian dollar exchange rate complex (AUD) has held up relatively well and why it could be a matter of time before the bottom gives way.

RBA’s Change Of Tone

For the first half of the year, the RBA spent much time and energy stating that “further depreciation in the Australian dollar seems both likely and necessary”.

Then recently, the RBA softened this message to “the AUD is adjusting to significant declines in commodity prices”; effectively lessening a negative reaction.

Market Pricing For The Fed

In anticipation of a US interest rate hike, the markets have reacted by reducing pricing for a September increase. Presently, pricing for September is less than 20%, and this is weighing in the USD.

Latest Pound / Australian Dollar Exchange Rates

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Iron Prices Remain Relatively Stable

The Chinese steel markets’ “blue sky rally”, a result of China’s continued effort to improve air quality, is driving a significant wedge between copper and oil, and iron ore and steel. Robert Rennie states, “As long as this continues, this is something that should continue to support the AUD.”

Japanese Demand Continues

Rennie notes that history has shown that “Japanese demand tends to rise as AUD/JPY drops to and through 90”. Currently, AUD/JPY continues to trade below 90; another explanation for AUD support.

Increased AUD Bond Issuance

Rennie speculates, “Helped by a flurry of Kangaroo bond issuance, this month is shaping up to be the best month for net issuance in combined ACBG, Semi and Kangaroo issuance back to May of last year” and “... increased issuance goes very much hand in hand with increased foreign demand...”.

The Upcoming 20 year Bond Future

Aligned to an increased AUD bond issuance, the forthcoming 20 year Australian bond future should support the AUD by catalysing demand for and liquidating the long end of the Australian curve.

Increased M&A Activity

Lastly, Rennie states “Having seen a boom in resource related M&A inflow through the 2010/2013 period that inflow declined through 2014 and into this year as the boom turned. However, more recent infrastructure related activity suggests this outflow will have slowed and turned.”

Robert Rennie makes no counter argument to the general consensus that the AUD will fall.

In fact, he sees the above factors as artificially supporting the AUD only in the near term and that the AUD will fall below 0.7000 by the end of year.

On August 24th, the unreliable nature of these superficial support factors became evident as the AUD/USD tumbled to a low of 0.7039 following morning chaos in American market as China’s stocks plunged. With a continued negative sentiment towards the AUD and its dependency on a weakened Chinese market, an AUD fall is almost guaranteed.

Watch September RBA Meeting, Construction Data

News of a Chinese interest rate cut has provided fleeting support to the Aussie dollar it would seem with a move higher to around 0.7250 in the wake of the cut soon giving way.

The next big hurdle for the AUD appears to be the RBA meeting pencilled in for the start of September.

We will be watching closely to see how Governor Stevens and his team react to the recent Asian market turmoil; could another interest rate cut be signalled?

Latest data meanwhile shows Australian 'construction work done' confounded market and our own expectations for a decline, rising 1.6% in the June quarter. This followed four consecutive quarters of decline.

Building work weakened in the quarter, as expected, falling 2.6%. Engineering construction, however, rose 5.6% in the June quarter, the first rise in seven quarters.

This was driven by a large increase in private engineering construction in WA in the quarter.