A booming economy, rising commodity prices, so why isn’t the Australian rallying?
The Australian dollar rebounded dramatically after the March 2020 drop against the US dollar. But although Australia’s economic recovery has strengthened, the recovery has stalled since March of this year. There are a number of factors that could dampen the positive background music, reversing some of the increase in commodity prices. But the real driving force behind the Aussie’s side action lately has been the flatter yield spread between Australian and US government bonds. However, with the Fed and RBA potentially signaling that they are relinquishing the accelerator in the coming weeks, are the calm waters about to be disrupted?
While relatively new to the game, it’s fair to say that the Reserve Bank of Australia has fully embraced quantitative easing (QE), having embarked on asset buying as well as debt programs. control of the yield curve since the onset of the viral crisis. It is probably also fair to say that the policies have been carefully and deliberately designed: setting the three-year Australian Government Bond (AGB) yield at the same level as the cash rate gives a very good indication of how long for which rates will remain low, while an asset purchase program focused primarily on 10-year yield keeps speculators at bay.
Undoubtedly, both policies have been successful in curbing the aussie’s advances, especially since March, when the RBA doubled its QE commitment. The RBA’s balance sheet has swelled since then, when a spike in AGB yields prompted both verbal and bond intervention. As a result, the Aussie has not been able to break past its February high since the start of the year, even though the US dollar has fallen significantly against April and other currencies like the British pound and the Canadian dollar hit new highs.
Little boost from soaring commodity prices
What makes the Aussie / Dollar pair’s resistance to bullish moves even more unusual is that real yields in the US have fallen as inflation expectations have soared, adding another drop for the greenback. . In addition, the price of raw materials, and in particular industrial metals – Australia’s main export – has skyrocketed in the past two months. Copper and iron ore futures have risen more than 30% year-to-date, and with demand likely to remain strong due to their use in many industrial and technological components, as well as of course in electric vehicles the australian currency should be on a roll.
After all, the economy is definitely reaping the rewards of the shift to electric vehicles and the general boom in global manufacturing, which are behind this surge in the prices of metals and other resources. Australia’s GDP grew at a better-than-expected quarterly rate of 1.8% in the three months ending in March, more than recovering from the pandemic crisis. The labor market has also rebounded impressively, and the unemployment rate is expected to drop back to pre-pandemic levels of around 5% soon.
Yield gaps are at work
So what is keeping the aussie at bay so tame? Currencies have surely defied returns before. Economic fundamentals and the broader theme of market risk certainly argue in favor of a stronger exchange rate. The slow rollout of the vaccine in Australia could undermine investor confidence in the outlook. Rising tensions with China could be another reason, as exports to Australia’s largest market are on the line due to Canberra siding with Washington on foreign affairs issues. However, while both factors have the potential to erupt into something bigger in the future, especially the latter, they have yet to make their mark on the markets and are currently low on the list of investor concerns. .
Thus, everything suggests that the aussie’s underperformance can be explained by the yield spread between Australian and US sovereign bonds, which tightened sharply in March. However, it is important to stress here that the yield spreads are supported by central bank policy and that a significant policy shift is looming on the horizon for both the Federal Reserve and the RBA.
Who will collapse first?
The Fed could signal that it will soon begin ending its QE as early as its June meeting in just under two weeks, while the RBA has already signaled that a major announcement is underway at its July meeting. However, it may be wrong to assume that this would represent the end of the RBA trying to outsmart the Fed and the start of a new race to get out of the pandemic stimulus.
In all likelihood, the Fed will try to stay as accommodating as possible, easing conical nervousness at every opportunity. But what’s more important is what RBA policymakers decide in July. Rumors suggest that the Bank will launch a plan to buy indefinite bonds. A weekly AGB buying target to be reviewed periodically could replace the latest A $ 100 billion round of quantitative easing when it expires in September.
RBA could surpass the Fed
Such a move could be powerful enough to keep the 10-year yield from climbing as the RBA gradually pulls out of the bond market, and all indications are that this will indeed be a slow process.
The RBA has made it clear that it wants to see wage growth reach 3% on a sustainable basis; it is currently half of 1.5% year-on-year. Policymakers believe this is crucial for inflation to rise and stay within the target range of 2-3%. But with an annual CPI of just 1.1% in the first quarter, there is still a long way to go and probably a lot more than what it will take for the Fed to meet its targets given that inflation is already on the rise. to soar in the United States.
Is the only way down for the aussie?
So where does all this leave the Australian dollar? If such a scenario were to occur, it is difficult to see the Aussie resuming its uptrend against the greenback anytime soon. After consolidating for more than three months, the 50-day Aussie / Dollar moving average (MA) has stabilized and the medium-term outlook for the pair is clearly neutral.
If the Aussie is unable to crush its February high of $ 0.8007 soon and continues to hover around the 23.6% Fibonacci retracement of the last rising leg, it will only be a matter of time before that the MA at 50 and 200 days do not meet. This could pave the way for a deeper retracement, drawing attention to the 50% and 61.8% Fibonacci levels of $ 0.7497 and $ 0.7377, respectively.
As it stands, yield dynamics trump strong Aussie fundamentals, weighing on the currency. This dynamic may well change over the next few weeks, but the odds for now are against the Aussie.