A Week of Reckoning for the AUD
Thursday, 19th September, Week 39
The Australian dollar has had a rollercoaster ride in recent weeks. Monday's fears of a US recession sent the AUD tumbling to a three-month low of $0.635. This move was exacerbated by the unwinding of yen carry trades, driven by the Bank of Japan's policy shift and global risk aversion. Yet, the AUD has since clawed back some ground, finding support from expectations of aggressive Fed rate cuts and robust Australian business activity data. Softer local inflation figures have also eased concerns about further RBA rate hikes. Understanding these dynamics will be critical for forex traders as we move forward.
Note that the audio is a conversation about the findings in this report. It is experimental AI, created by Google NotebookLM.
Dominant Theme: RBA Policy Stance and Inflation's Grip
The most influential theme shaping trader sentiment towards the AU and the AUD over the past month has been the RBA's unwavering commitment to taming inflation, even as economic growth softens. The RBA has kept the cash rate unchanged at its past six meetings, and it's statements consistently express concern about inflation's persistence. This creates a complex dynamic for the market, with hopes for an eventual rate cut to support growth, battling the reality of the RBA's current restrictive stance.
Timeline:
August 30th: Softer-than-expected local inflation data prompted the AUD to climb past $0.65, hitting a three-month high. The data eased bets on another immediate RBA rate hike.
August 6th: The RBA held the cash rate steady at 4.35%, marking the sixth consecutive meeting without a change. However, the accompanying statement highlighted concerns about inflation proving more persistent than anticipated.
August 2nd: The AUD reached an eight-month low, falling below $0.65 as the USD strengthened and investors absorbed news of Australia's contracting manufacturing sector.
July 11th: The July CPI data showed a 3.0% year-on-year increase, confirming that while inflation is moderating, it remains a persistent challenge for the RBA.
The Geopolitical Landscape
Geopolitical events are rarely far from the minds of forex traders, but the assassination of Hamas' political leader, Ismail Haniyeh, in Tehran on July 31st has brought them sharply into focus for those watching the AUD. This event has injected volatility into oil prices, prompted a flight to safety among investors, and added a layer of uncertainty to the global outlook.
"Israel's preemptive strike doctrine is likely lowering its political threshold for action amid growing threats from Iran and its network of allies, but this shift is unlikely to deter future strikes on Israel and will instead increase the risk of sparking a larger regional war." - Stratfor, August 29th, 2024
The potential for escalating tensions in the Middle East, including retaliatory strikes from Iran, is a significant risk for the AUD. Any disruption to global energy markets or further destabilisation of the region could negatively impact risk sentiment and weigh on the AUD. Additionally, Australia's strong trade ties with China make it vulnerable to any escalation in tensions between China and the US. The upcoming weeks will be crucial for monitoring developments in the Middle East and assessing their potential impact on the AUD.
Fiscal Policy
Australia’s fiscal policy is currently balancing a commitment to responsible economic management with the need to support a slowing economy. The 2024-25 Budget, released in May, delivered a range of cost-of-living relief measures, including tax cuts, energy bill relief, and increased rent assistance. It also outlined a "Future Made in Australia" plan, focusing on investing in renewable energy, critical minerals, and clean manufacturing.
"The 2024-25 Budget delivers cost-of-living help and builds a future made in Australia. It helps ease the pressures people are under today, invests in a stronger and more resilient economy and continues the Government’s record of responsible economic management." - Australian Government Budget Paper No. 1, May 14th, 2024
The coming month will focus on the effectiveness of these fiscal measures in easing inflationary pressures and stimulating economic activity. The government's success in securing private investment for its ambitious "Future Made in Australia" plan, while navigating potential supply chain disruptions, will be crucial for long-term economic resilience. The AUD's attractiveness to foreign investors will be tied to how this unfolds. Additionally, the implementation of social housing initiatives will be closely watched as the government seeks to address Australia's housing affordability crisis.
Economic Fundamentals
Australia's economy is at a crossroads, facing moderating inflation, easing labour market conditions, and a persistent lack of housing affordability. Consumer sentiment remains subdued as households grapple with cost-of-living pressures, while business confidence navigates global economic uncertainties.
"Australia’s housing system has been too slow to respond to demand. The causes of this are multifaceted, complex and affect all stages of the housing construction process, including all levels of government and industry." - Australian Government Budget Paper No. 4, May 14th, 2024
The upcoming month will be critical for understanding the trajectory of these fundamentals. The release of the August CPI data on September 25th will be crucial for gauging the RBA's success in controlling inflation. The August employment data, due on Thursday, September 19th, will provide insights into the pace of labour market easing and its impact on wages. The performance of the housing sector, including building approvals and housing credit growth, will be closely monitored, as affordability concerns persist.
Monetary Policy
The RBA is currently walking a tightrope between its mandate to return inflation to the 2-3% target band and the need to support a slowing economy. The decision to hold the cash rate steady at 4.35% for the sixth consecutive meeting reflects this balancing act. While the RBA acknowledges the recent moderation in inflation, it remains concerned about its persistence, particularly in services prices.
"Returning inflation to target within a reasonable timeframe remains the Board’s highest priority. This is consistent with the RBA’s mandate for price stability and full employment." - RBA Statement on Monetary Policy, August 6th, 2024
The coming month will offer clues about the RBA’s evolving stance. The August CPI data will be a key factor in the RBA's decision at its next meeting on Tuesday, September 24th. If inflation shows signs of reigniting, the RBA could raise interest rates again, potentially strengthening the AUD. However, further moderation in inflation could embolden the RBA to signal a rate cut, potentially weakening the AUD. Traders will be watching closely for any shifts in the RBA’s forward guidance and its assessment of the labour market.
Macroeconomic Outlook
The macroeconomic outlook for Australia is one of cautious optimism, with inflation projected to return to the RBA's target band, a gradual easing of the labour market, and a continued recovery in economic activity. However, both domestic and global uncertainties cloud the picture. The trajectory of inflation, the pace of labour market easing, and the performance of the housing sector are key domestic factors to monitor. Globally, the risk of a US recession, the US-China trade war, and escalating geopolitical tensions in the Middle East all have the potential to disrupt the outlook.
The Australian dollar is expected to trade within a range in the near term, influenced by the balance of these forces. But the AUD's sensitivity to global risk sentiment and commodity prices means traders should be prepared for bouts of volatility. Geopolitical events and unexpected US economic data could easily trigger swings in the AUD.
Key Economic Indicators to Watch
RBA Interest Rate Decision (Tuesday, 24th September, Week 40): Market consensus is for the RBA to hold the cash rate steady at 4.35%. A rate hike would be an unexpected hawkish surprise and could boost the AUD. A rate cut would be a dovish signal, likely weakening the AUD. A hold, paired with a statement emphasizing inflation risks, would probably support the AUD. A hold, with a more dovish tone suggesting potential future rate cuts, could weaken the AUD.
Australian CPI Indicator (Wednesday, 25th September, Week 40): Forecast: 3.80%. If inflation matches this forecast, it would confirm the persistent, though moderating, nature of inflation. A higher-than-expected reading could strengthen the AUD on the expectation of further RBA tightening, while a lower-than-expected result could weaken the AUD on increased rate cut bets. This indicator is a lagging indicator.
Conclusion
The Australian dollar has been navigating a complex landscape, influenced by global risk aversion, a volatile commodity market, and the RBA's efforts to balance inflation and growth objectives. The coming week will be pivotal, with the RBA's interest rate decision and the release of key economic data, including CPI and employment figures, shaping the AUD's path.
The coming week will likely see continued volatility for the AUD. Market focus is squarely on the RBA's interest rate decision on Tuesday, 24th September, and the release of the August CPI data on Wednesday, 25th September. The AUD could weaken if the RBA signals a dovish tilt or if inflation shows signs of re-accelerating. Conversely, a hawkish RBA statement or further moderation in inflation could support the AUD.
Sources
Reserve Bank of Australia
Australian Bureau of Statistics
Australian Government Budget Papers
Trading Economics
Bloomberg
Westpac Banking Corporation
Melbourne Institute
National Australia Bank
S&P Global
Australian Industry Group
CoreLogic
Stratfor