RBA vs. the World: The AUD's Fate Hangs in the Balance
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Wednesday, 25 September 2024 Week 39
This report delves into the macroeconomic outlook for the Australian dollar (AUD) and the commodities intrinsically linked to its performance – iron ore and coal.
Several factors are currently shaping the Australian economic landscape. The Reserve Bank of Australia (RBA) is locked in a battle to curb inflation, a commitment reflected in its decision to keep interest rates at an elevated level. However, the persistence of inflationary pressures is undeniably challenging the central bank's strategy. Further complicating the picture, China’s ongoing economic slowdown poses a significant risk to the AUD, with implications for demand for Australian exports, particularly iron ore. Adding another layer of uncertainty, geopolitical tensions, particularly those simmering in the Middle East, are injecting further volatility into these interwoven markets.
RBA's Hawkish Stance and China's Slowdown: A Delicate Balancing Act
Two dominant themes have been shaping market narratives surrounding the AUD, iron ore, and coal: the RBA’s hawkish stance and the economic slowdown in China. These contrasting forces are creating a complex and uncertain environment for traders and investors.
The RBA has held the cash rate steady at 4.35% for the seventh consecutive meeting. This decision, while widely anticipated, underscored the central bank’s resolute commitment to curbing inflation, which remains above its target range of 2–3%. While the monthly CPI indicator eased to 2.7% in August, it was slightly below market forecasts of 2.8%. However, the RBA’s concerns about persistent inflation, particularly given the tight labour market, remain a key driver of its hawkish stance. This commitment has prevented a steeper decline in the AUD, offering some support to the currency.
Conversely, the ongoing economic slowdown in China, Australia's largest trading partner, is casting a long shadow over the AUD and its associated commodity markets. This slowdown is weighing heavily on demand for iron ore and coal, impacting commodity prices and adding to the AUD's vulnerability. Weakening economic data from China, including slowing industrial production, manufacturing output, and retail sales, is reinforcing these concerns.
An emerging theme further complicating the situation is the growing uncertainty regarding the US economic outlook. Fears of a US recession, fueled by recent weaker-than-expected US economic data, have sparked a sell-off in risk assets across the globe. This risk-off sentiment has negatively impacted the AUD, which often acts as a proxy for risk appetite.
Navigating the Middle Eastern Storm
The geopolitical landscape, particularly the escalation of tensions in the Middle East, is adding a significant layer of uncertainty to the outlook for the AUD, iron ore, and coal.
This volatile situation poses a clear risk to the AUD and its interconnected commodity markets. Should the conflict escalate further, it could trigger a significant risk-off move in global markets, boosting safe-haven assets like the US dollar and potentially triggering a flight from riskier currencies like the AUD. The potential disruption to global trade and energy markets, particularly if oil supplies are affected, could also have significant negative consequences.
The ongoing US-China trade war is another geopolitical factor adding to the uncertainty. The unpredictable nature of this trade dispute and its potential impact on global growth and demand for commodities is creating a challenging environment for Australian exporters.
Cost-of-Living Relief and Responsible Spending
The Australian Government’s fiscal policy is balancing a commitment to providing cost-of-living relief with maintaining fiscal discipline. This delicate balance is evident in the 2024-25 Budget, which aims to ease pressure on households while keeping the budget on a sustainable path. The government achieved a surplus of 0.90% of GDP in the 2022-23 fiscal year and projects another surplus of 0.3% for the current fiscal year (2023-24).
Key fiscal policy initiatives that have shaped the current economic environment include:
Tax Cuts: The Budget provided tax cuts for all 13.6 million Australian taxpayers, averaging $1,888 per individual.
Energy Bill Relief: The Budget extended and expanded energy bill relief to provide $300 to every household and $325 to around one million small businesses, effective from July 1st, 2024.
Pharmaceutical Benefits Freeze: The maximum co-payment for Pharmaceutical Benefits Scheme medicines was frozen for one year, with a five-year freeze for pensioners and concession cardholders.
Commonwealth Rent Assistance Increases: The Budget provided two consecutive increases to Commonwealth Rent Assistance maximum rates: 15% in the 2023-24 Budget and an additional 10% in the 2024-25 Budget.
These initiatives aim to support households facing rising costs and potentially boost economic activity. However, the effectiveness of these measures in stimulating growth while managing inflation remains to be seen. The impact of the tax cuts on inflation will be closely monitored, as will the government's ability to secure private investment for its ambitious "Future Made in Australia" plan.
Tight Labor Market, Slowing Growth, and Easing Inflation
The labour market continues to perform well, but growth in the economy as a whole has slowed.
Key Economic Indicators:
GDP: Growth remains subdued, with GDP expanding by just 0.2% qoq in the second quarter of 2024, marking the weakest pace in five quarters. The annual GDP growth rate for 2023–24 was 1.5%, the slowest since 1991–92, excluding the COVID-19 pandemic. This recent weakness in GDP growth reflects softening domestic demand, particularly household consumption.
Inflation: Inflation in Australia is showing signs of easing. The annual headline inflation rate came in at 3.8% in the second quarter of 2024, slightly higher than in the previous quarter. However, the trimmed mean measure of core inflation slowed to 3.9% in Q2, suggesting some easing in underlying inflationary pressures.
Employment: Australia’s labour market continues to perform strongly. Employment surged by 47,500 in August of 2024, exceeding market expectations. The unemployment rate, however, remained at 4.2%, a 2.5-year high.
Retail Sales: Retail sales in Australia have slowed, with July retail sales stagnating year-on-year. This weakness reflects a decline in consumer spending, driven by cost-of-living pressures and tighter financial conditions.
Trade Balance: Australia’s trade surplus widened to AUD 6.01 billion in June 2024, driven by robust export growth. However, this surplus narrowed to AUD 5.6 billion in July, highlighting the impact of China's economic slowdown on demand for Australian exports.
Monthly CPI Indicator: The monthly CPI indicator eased to 2.7% in August, the lowest since August 2021.
The upcoming month will be crucial for monitoring the evolution of Australia’s economic situation. Several key data releases are expected to provide further insight:
August retail sales data (due Tuesday, 1st October, Week 40): A rebound in retail sales would suggest a recovery in consumer spending and support the AUD, while continued weakness would signal a slowing economy and weigh on the currency.
The Ai Group Industry Index (due Wednesday, 2nd October, Week 40): A positive reading could signal a turning point for the manufacturing sector, offering some support to the AUD. A further contraction would reinforce concerns about the economy and the currency.
The Balance of Trade (due Thursday, 3rd October, Week 40): A widening trade surplus could bolster the AUD, reflecting strong demand for Australian exports. A narrowing surplus or a deficit could weigh on the currency.
The Hawkish Hold
The RBA remains focused on bringing down inflation. The central bank is currently walking a tightrope, balancing its inflation-fighting goals with the need to support a slowing economy. The decision to hold the cash rate steady at 4.35% for the seventh consecutive meeting, while widely anticipated, highlights this ongoing balancing act.
Key Monetary Indicators:
Cash Rate: The RBA has maintained the cash rate at 4.35% since May 2024.
Inflation: While inflation is moderating, it remains above the RBA’s 2–3% target range.
Market Expectations: Currently, market pricing implies that the RBA will keep rates unchanged until early next year before starting to ease monetary policy.
Recent Monetary Events:
RBA's Decision to Hold: The RBA’s recent decision to hold the cash rate steady in September, after its meeting on the 24th, highlighted its continued hawkish stance.
Softer-Than-Expected Inflation Data: Softer-than-expected inflation figures for the second quarter have tempered market expectations for further aggressive rate hikes by the RBA.
Global Monetary Policy Shift: The US Fed's 50-basis-point rate cut in August has triggered a reevaluation of the global monetary policy landscape. This shift could put pressure on the RBA to consider easing its policy stance sooner than previously anticipated. However, the RBA has indicated that its decisions will be guided by domestic inflation dynamics and has shown no signs of deviating from its focus on taming inflation.
"Conditions in the labour market could deteriorate by more than expected. At its August 2024 meeting, the Reserve Bank Board decided to hold the cash rate. Inflation in underlying terms remains too high and it will be some time yet before inflation is sustainably in the target range." - Reserve Bank of Australia Statement on Monetary Policy - August 2024
Several key events in the upcoming month will be closely monitored for their potential impact on the RBA’s monetary policy stance:
Release of the RBA’s Financial Stability Review (due Thursday, 26th September, Week 39): This will offer an updated assessment of the health of the financial system and its resilience to potential risks, including those stemming from the housing market and household debt levels.
Release of the September quarter CPI data: These data, due to be released later in October, will be crucial for shaping expectations for the RBA's policy stance in the months ahead.
Navigating the Uncertainties Ahead
The Australian macroeconomic outlook is clouded by uncertainty. The economy is projected to recover, but a confluence of external and internal factors creates a challenging environment for policymakers, businesses, and investors.
Several key factors are shaping the current macroeconomic landscape:
Inflation: Inflation remains a persistent challenge for the RBA.
Economic Growth: Growth is projected to pick up in 2025, but there are downside risks stemming from a potential US recession, geopolitical tensions in the Middle East, and ongoing weakness in the Chinese economy.
Labour Market: Despite signs of easing, labour shortages persist, putting upward pressure on wages and contributing to the persistence of inflation.
Housing Affordability: Housing affordability remains a significant concern, impacting consumer confidence and potentially hindering growth in household consumption.
These interwoven factors will play a crucial role in shaping the path of the AUD and its associated commodity markets over the coming months.
Key Economic Indicators to Watch
In the upcoming month, several crucial economic indicators are set to be released that will further illuminate the trajectory of the Australian economy and potentially influence the RBA's next policy move.
August Retail Sales (due Tuesday, 1st October, Week 40): A rebound in retail sales would suggest a strengthening in consumer spending and could be positive for the AUD. However, continued weakness would confirm the slowdown in consumption and likely weigh on the currency.
Ai Group Industry Index (due Wednesday, 2nd October, Week 40): The forecast is -10. A further decline in the index would reinforce concerns about Australia's manufacturing sector. Conversely, a better-than-expected result could suggest a potential turning point and offer some support to the AUD.
Balance of Trade (due Thursday, 3rd October, Week 40): The forecast is AUD 8.20 billion. A widening trade surplus would be a positive sign for the AUD, reflecting strong demand for Australian exports. A narrower surplus or a deficit would likely weigh on the currency, particularly if driven by weaker exports.
Westpac Consumer Confidence Change (due Thursday, 10th October, Week 41): The forecast is 2.00. An increase in consumer confidence would suggest that households are more optimistic about the economic outlook, which could be positive for the AUD. However, a decline would reinforce concerns about the economy and impact the currency.
NAB Business Confidence Index (due Thursday, 10th October, Week 41): The forecast is 5.00. Strong business confidence could support the AUD, while a decline would be a negative signal for the currency.
Australian Employment Change (due Thursday, 17th October, Week 42): Robust employment growth would support the view of a strong labour market and could lead to a stronger AUD. However, a decline in employment growth, particularly if accompanied by a rise in the unemployment rate, would signal weakness in the labour market and potentially trigger a sell-off in the AUD.
Unemployment Rate (due Thursday, 17th October, Week 42): The forecast is 4.2%. An increase in the unemployment rate would suggest further easing in labour market conditions. This could increase the likelihood of an RBA rate cut, potentially leading to a weaker AUD. A decline would be supportive of the AUD.
Sources
The Reserve Bank of Australia (RBA), Australian Bureau of Statistics (ABS), National Australia Bank (NAB), Westpac Banking Corporation, Melbourne Institute, S&P Global, Australian Industry Group, Judo Bank, Trading Economics, Stratfor, CBA