Australian Dollar Weakness Ahead Warns Swissquote's Masset

Is the Aussie Dollar's impressive 2016 rally about to come to an end? One leading FX analyst tells us why this could indeed be the case.

• The Pound to Australian Dollar exchange rate: 1.7211, this week's best = 1.7226
• The Australian to US Dollar exchange rate: 0.7628, this week's best = 0.7749
• The Australian to New Zealand Dollar exchange rate: 1.0503, this week's best = 1.0675

Despite this week's soft trading patterns, the Australian Dollar still remains one of the outperformers for 2016 in global FX.

And, we have recently written a piece here noting that the outlook for the currency remains positive when the dynamics in the coal and iron ore markets are also taken into account.

However, the story is a complex one, and to ensure our readers have as broad an understanding of the dynamics facing AUD, we bring the views of Swissquote Bank’s Arnaud Masset.

Masset believes believes that it could be time for some AUD weakness, particularly in the AUD/USD exchange rate.

While weakness in AUD/USD could have some spillover into the GBP/AUD exchange rate, we still view any sustained GBP/AUD recovery as unlikely at this stage.

Central Bank vs Central Bank

The basis of Masset’s forecast for weakness in the Australian Dollar is based on the ever-evolving dynamics between the big global central banks that ultimately drive currency moves.

Australia’s central bank faces a number of challenges:

1) Weak inflationary pressure
2) An economy that is at the mercy of slowing demand from China
3) Robust house prices, particularly in Sydney
4) A strong currency, which acts a barrier to boosting exports, particularly those from the services and manufacturing sectors

We have noted on many an occasion that the strength of the Australian Dollar largely stems from the carry trade - a strategy whereby investors in places like the UK, Eurozone and Japan chase the higher yields on offer in Australia.

Therefore, the Reserve Bank of Australia has been keen to diminish this driver of the AUD by cutting interest rates.

“In spite of two interest rate cut in less than four months (May and August), the Australian dollar remains under heavy buying pressure as monetary easing becomes the new normal amongst central banks,” says Massett.

This implies that a rate cut or two is no longer enough to guarantee a lower currency in a world where rates are being aggressively slashed.

Latest Pound / Australian Dollar Exchange Rates

	Live: 2.0112▼ -0.24% 12 Month Best: 2.1645
*Your Bank's Retail Rate	1.9428 - 1.9509
**Independent Specialist	1.9831 - 1.9911 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

It feels like the RBA is cutting just to stand still!

Back in May, the first rate cut had the expected effect as investors closed their long Aussie positions.

At that point the market was still fearing the central bank, ready to play its game by staying away from the AUD.

“However, at the time of the second rate cut in August, the market already had plenty of time to question the central banks’ ability to actually drive their respective currency,” says Masset.

Elsewhere, the failure of the BoJ to effectively weaken the yen has opened the door for a broader questioning of ultra-accommodative monetary policies.

“Therefore, the effect of the August rate cut was short lived as AUD/USD climbed back to its initial level in less than a week,” says Masset.

It is becoming increasingly evident that central banks are losing their grip on FX when they want to weaken their respective currencies.

However, Masset argues that expectations for interest rate rises command currency responses.

This is especially true when the central bank has inflation expectations under control, it is argued.

“Therefore, we would not be surprised to see the Aussie weaken in the next few weeks - especially against the greenback - as the market (again) anticipates the Fed to increase borrowing costs,” says Masset.

Therefore, Australian Dollar weakness, as a function of central bank policy, will likely be externally driven going forward.

Luckily for the RBA, the US Fed still appears intent on moving in the opposite direction.

Strong Labour Market Data Underpins Economic Fundamentals

The Australian Dollar certaintly has come off the boil against its main competitors this week.

The declines come despite some encouraging labour market statistics which showed the country added 26.2K jobs, ahead of the 11K forecast by economists.

The unemployment rate has slipped to 5.7%, down from 5.8% in June.

Strong growth data such as this is always unambiguously positive for a currency.

"The RBA would likely be pleased with the firmer tone to today’s numbers, although we continue to see them on hold with the risk of further cuts given persistently low inflation," says Felicity Emmett at ANZ Research.

So while central bank dynamics may ultimately have the final say on where AUD goes from here, the domestic currency will likely remain supported whenever domestic fundamentals are in the driving seat.