The Australian dollar remains under pressure having suffered a hero to zero status shift earlier in the week. But there are positives to be found when we look forward a couple of months.
- AUD now most vulnerable commodity currency to a rising US dollar should US interest rates rise
- However, Templeton Emerging Markets Group advises investors to position for a commodity rally; good news for the Aussie dollar long-term
Australia's central bank surprised the market with a 25bp rate cut, sending the Australian dollar to its lowest level in more than 5 weeks.
Traders went into the event being aggressively long on the Australian dollar anticipating further advances.
As such, speculative positioning was seen hovering at the highest levels in nearly a year suggesting the market had, and still has, plenty of weight to shed.
As traders are forced to bail out of bets on the Australian dollar so we would expect the currency to depreciate further in the nearer-term.
At the time of writing the Australian dollar trades at 0.7474 against the US dollar, down from a pre-RBA high of 0.7719.
The GBP to AUD exchange rate is seen at 1.9381, higher than the 1.90 seen ahead of the RBA decision.
Why Australia’s Central Bank Cut Interest Rates
The Reserve Bank of Australia (RBA) decided to cuts interest rates by 25bp to 1.75% citing the following risks to the Australian economy:
- A lower outlook for inflation making reference to the recent Q1 CPI release as being unexpectedly low
- More mixed labour market indicators of late
- Housing price pressures tending to abate as lending standards strengthen – here RBA is particularly deliberate in saying it has taken careful note of developments in housing and impact of lower rates
- Policy makers noted the recent revision down in global growth forecasts by major international forecasters
The RBA is concerned about the rising AUD as likely to complicate economic adjustment from an economy that is focussed on raw resource extraction to one based on manufacturing and services.
Another Interest Rate Cut Coming
The RBA is likely to follow the May interest rate cut with another rate cut in the near-term despite the forward guidance in the May media release not being explicit on the matter.
It is noted that historically the RBA tends to follow one cut with a second and analysts don’t expect this time to be any different.
The question of the exact timing of the cut is a little harder to establish though.
Economists at Citi say they expect another rate cut in August if inflation data is lower than expected.
Australian Dollar Exposed to an Interest Rate Hiking Fed
As a result of the lower profile for Australian interest rates Citi’s economic analysts now believe the Australian dollar to be the most vulnerable within the G10 should the US Federal Reserve start pursuing a more aggressive stance on raising interest rates.
Higher rates in the United States will likely result in the flow of funds to Australia dry up. The situation will be exaggerated when the yield advantage in Australia is cut by the RBA, potentially to 1.5%.
We have already seen an improvement in the USD’s fortunes at the start of the new month with two US Federal Reserve policy makers suggesting rate rises may take place in 2016.
If the US Federal Reserve is to strike a more positive tone on the economy and raise rates in June then we may now be witnessing the end of the dollar’s poor run that has characterised trade for much of 2016.
This leaves the commodity-orientated currencies, of which the Australian and Canadian dollars are standard bearers, looking particularly exposed.
A strengthening dollar tends to suppress demand for commodities as they are denominated in USD.
Furthermore, Citi Economists now estimate it may take up to 3 quarters before Australian inflation is back within the RBA’s 2-3% tolerance band, which potentially guarantees that further rate cut from the RBA.
“AUD is therefore seen to be more vulnerable to a turn in USD sentiment – which also makes it vulnerable on crosses such as sterling and euro which have recently found more resilience,” say Citi.
With AUDUSD dropping more than 150-pips post RBA and trading below trend line support at 0.7545-49, the CitiFX Technical team suggests a retest of 0.7385 especially if the short covering in USD continues post the US April jobs report.
Some analysts do not see the RBA rate cut as the death-knell for the AUD appreciation story however and overall, the currency remains well supported in the low 0.7000-0.7200 area even if the Fed were to proceed with a June hike.
The Longer-Term Outlook: Position for a Commodity Rally
Mark Mobius, pioneer in Emerging Markets investing and Executive Chairman of Templeton Emerging Markets Group is reported to be piling into commodity stocks in China.
Mobius, regarded as “a legend in emerging market investment by any standard,” by analysts at SP Angel, the boutique commodity brokerage in London, reckons the rebound in raw materials markets is only getting started and that China’s commodity producers are leading this year’s recovery.
“We agree with Mobius in that we believe the Chinese government is working to kick start dozens of local rail infrastructure projects which will consume most or all of China’s excess steel production. We note China still plans to close inefficient capacity in its smokestack industries,” say SP Angel in a briefing to clients on Wednesday the 4th of May.
Traders have stocked up metal and ore inventories in China in anticipation of the new demand but some wonder if parts of the government are resisting orders to free up cash to feed the new projects.
“We might well be in for another ‘bull’ run in commodities but we won’t know for sure till we see inventory the draw down needed to feed the development of a significant number of new projects,” say SP Angel.
Copper, steel (iron ore), nickel, zinc, tin and aluminium should all gain as manufacturers ramp up production of cables, rails, fixings and new trains.
And when these commodities rise, you can bet the Aussie dollar will do to.
So while the RBA may be forced to cut interest rates and suppress the Australian dollar in the near-term, we may be looking at a very different environment by the end of 2016.