BNY Mellon: The Aerial View: Up From Down Under

9 november 2018

By Neil Mellor, Senior Currency Strategist, BNY Mellon

The USD’s gyrations have allowed the AUD to recover its composure after a lamentable first ten months of the year. But what happens next may still depend to a large extent on Australia's largest trading partner.

As of the end of October, the AUD had ceded 13% to the USD since its highs at the start of the year – a performance that hardly put it alongside the worst of the G20’s performers, certainly, but one that was marginally worse than the Brexit-blighted pound (-11%).

One week on, however, and the AUD has recouped 3% and more significantly, it now stands above a year-to-date downtrend that has proven an ironclad restraint to the currency’s ambitions.

If only for the extremity of positioning against the currency (as shown by CFTC data), there is certainly a prospect of the AUD building on these gains (although that said, these positions accrued gradually and in lockstep with the AUD’s slide from the start of the year).

More significant is the USD’s likely path. It may be too early for either bulls or bears to declare victory following the mid-terms/FOMC, but from a yield perspective at least, the AUD remains at a distinct disadvantage to the USD: the two-year yield spread between sovereign US and Aussie debt stands barely 2 bps above 21-year lows, while the picture is only marginally better for the 10-year.

Although raising its growth and inflation forecasts today, we feel confident that the RBA is not about to give the AUD a helping hand – the RBA is a central bank that has been fairly transparent about the shortcomings of an uncompetitive AUD (particularly against a currency in which Australia’s principal produce is priced).

Certainly, there was little sign of the Bank looking to restrain the bears as the Aussie approached the 70 cent marker last month, and its policy statement this week was pointedly insinuation-free on matters of currency: "the AUD", it noted, "is currently in the lower part of [its two-year range] on a trade-weighted basis". Well, yes, it is.

But as ever, to have a view on the AUD is really to have a view on China.  The AUD’s largest daily moves this year have all been instigated, directly or indirectly, by China-related news (Feb 2, June 14, July 11, Aug 31 and so on) - unsurprising, perhaps, given that the weekly inverse correlation between AUD/USD and USD/CNH has risen to 72% this year from just 40% back in 2010.

As we suggested earlier this week, China may not be slowing as quickly as recent data would appear to suggest: while PMI data point to a stagnating manufacturing sector, for example, electricity consumption is growing by 8.9% y/y.

Our concern is that the distinct complications in treading a fine line between deleveraging and ensuring stability are being complicated by China’s ongoing stand-off with the US on trade.

Ironically, there was a warning of things to come on this front from yesterday’s stellar export figures from China. Growth of 15.6% far exceeded expectations of a slowdown, but then it is well understood that exporters have been “front loading” order completions to avoid US tariffs. And perhaps as a direct consequence of this, order books have been shrinking steadily since June according to PMI data.

So, the AUD has escaped the punishing gravity of its year-to-date downtrend