The Aussie dollar has enjoyed a number of tailwinds so far this month, and is the second best performing G10 currency.
A contained local covid-19 outbreak, relatively hawkish central bank, and improving general global risk appetite were all among the tailwinds that enabled AUD to continue to rally in May. Looking ahead, the easing of lockdown measures and improving global growth are likely to continue to provide support for further appreciation in the G10 currencies in general.
Within this group, AUD’s combination of tailwinds and favorable idiosyncratic characteristics suggest it is likely to remain a strong performer.
The modest domestic outbreak, the RBA’s relative aversion to negative rates, and the inherently high sensitivity of AUD to risk appetite and global growth, mean AUD has good prospects to perform well relative to both USD and the G10 basket.
However, despite our bullish base case for AUD, the rest of the year holds two significant wild cards that could derail both risk appetite in general, as well as hit AUD on an idiosyncratic basis. As with global markets in general, a worsening of the global covid-19 pandemic will send risk assets back down and put AUD on the back foot. A sudden worsening in US-China relations, for example in the run-up to the US Presidential election, would worsen global risk appetite but also be particularly harmful to AUD.
AUD performance in middle of G10 currencies since beginning of year
AUSSIE DOLLAR ENJOYS TAILWINDS FROM GENTLE SHOCK TO ECONOMY AND RBA AVERSION TO NEGATIVE RATES
The relative success of containment measures in Australia have significantly slowed transmission of covid-19. Australia implemented restrictions similar, although slightly more lenient, than those imposed elsewhere in the world relatively early in the “curve” of its domestic outbreak. As a result, total covid-19 cases have remained below 10,000 with less than 150 deaths. In recent weeks transmission appears to have been all but halted. This allowed Prime Minister Scott Morrison to announce a phased re-opening approach on the 7th May that has seen a partial re-opening of significant parts of the economy.
The relatively early re-opening of parts of the economy has important implications for the depth of the overall blow to gross domestic product and employment.
The Reserve Bank of Australia envisages a 10% peak-to-trough fall in GDP in the second quarter, including a large fall in consumption, and a peak unemployment rate of around 10%. It is very early, but these figures look likely to compare well to several major G10 peers, most notably larger economies such as the UK, France, and the United States. Official unemployment data showed a net loss of 594,000 jobs in April, or roughly 5% of total employment. However, the relaxing of lockdown measures, as well as the Government’s job retention scheme may have meant further losses were prevented. Experimental weekly payrolls data from the Australian Bureau of Statistics showed than in the two weeks ended on May 2nd total jobs declined only 0.2%, and rose in the retail and food & accommodation sectors.
AUDUSD rallies after sharp losses in March
RBA AVERSION TO NEGATIVE RATES LIKELY TO GIVE AUD AN EDGE
Unlike several peers, such as the RBNZ and Bank of England, RBA messaging has shown significant aversion to the prospect of negative rates. On a relative basis, the RBA may arguably even be hawkish among the other G10 central banks, as hinted at by forward pricing of overnight index swaps.
In recent meeting minutes, as well as the May Statement on Monetary Policy, the RBA has suggested monetary policy will be on hold for the near future and there has been little if any discussion of further major easing measures.
Although the latest minutes noted the economy was experiencing a “deep economic contraction”, members also discussed the “timing and size” of economic shocks facing global economies, in a possible nod to the relatively good conditions in the Australian economy. Neither the minutes nor the statement contained any nods to further measures, with the former stating that members agreed current policy settings should be maintained. RBA Governor Philip Lowe has been consistent in playing down the possibility of negative interest rates. Speaking in an online Panel on 21st May, Lowe reiterated that negative rates in Australia are “extraordinarily likely”, a phrase he used in November 2019.
Forward pricing over overnight index swaps in various G10 economies shows that market participants have taken Lowe’s messaging to heart. During a period of speculation about negative rates in major economies, forward pricing of OIS contracts in AUD remained stable, while equivalent contracts in USD and GBP fell into negatives.
The expectations may be significant for AUD: if the RBA stays firm in avoiding negative rates, the currency is likely to have an edge over G10 peers. This is especially true given the relatively good macro conditions in Australia.
Market pricing reflects RBA aversion to negative rates
Author: Ranko Berich, Head of Market Analysis