AUD/USD Weekly Outlook August 29-September 2

AUD/USD traded in a range for most of the last week, ahead of Janet Yellen’s speech. Friday’s price action displayed volatility as the exchange rate posted both a high for the week, as well as a low. The net result was a push lower resulting in a technical break.

The US Dollar drove the FX markets on Friday, as the Fed chair’s speech encouraged rate hike speculation. A specific mention of improvements in the labor markets, and that a case could be made for a rate hike, caused the Dollar to surge higher after an initial period of volatility. Futures markets are now showing a 59.1% chance of a rate increase by the end of the year, the highest level since the EU referendum.

Commodity currencies were seen somewhat containing losses on the week. AUD/USD posted a loss of 0.77% on the week, as the pair had made a break higher ahead of the event. The pair broke higher from its weekly range on Friday at the New York open reaching a high of 0.7674 ahead of the speech. The initial volatility in the Greenback as Yellen commenced triggered an extension for a high of 0.7691, marking the high on the week. The pair closed out the day at 0.7558, bringing the pair below the daily close of the last RBA rate cut.

A US rate hike stands to have bearish implications for AUD/USD, as a speech by Glenn Stevens, before he stepped down as RBA Governor, indicated the importance of the Fed in Australia’s monetary policy. Stevens addressed the difficulty in lowering the exchange rate while the Federal Reserve maintained a loose monetary policy. The RBA may look to capitalize if the Fed proceeds with its rate hike cycle, as further cuts in the Australian interest rate would have a much more profound impact on the Aussie Dollar if monetary policies are seen diverging.

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HIA Australian new home sales -9.7% m/m vs +8.2% m/m prior

Australia - ANZ Roy Morgan weekly consumer sentiment: 118.4 (prior 121.8)

• A strong bounce in the previous week
• But this week views fell
• Looking through the week-to-week volatility the trend in confidence is clearly higher

AUD/USD Attempts To Recover From Horizontal Support

Broad-based strength in the US Dollar seen in the early week triggered a drop to new lows for the week for AUD/USD, but the pair managed to catch a bid near support found at the 0.7500 handle late in the North American session on Tuesday and is seen attempting to push higher from the level today as the US Dollar falls back.

The US Dollar index (DXY) had a strong start to the week but was met with resistance at the North American open today. The index rallied to a high of 96.26, while a Fibonacci cluster at 96.24 served to turn DXY lower. The level references an 88.6% Fibonacci level measured from August 5 highs, as well as a 61.8% Fibonacci level measured from the July 24 highs. After a period of consolidation, the index is seen breaking below a rising trendline from Monday’s low seen on an hourly chart. The weakness in the Greenback has boosted the AUD/USD higher, as the pair has posted a bullish candle on the 4-hour chart.

The ADP report non-farm employment change numbers today, the report indicated an additional 177,000 people gaining employment in August, exceeding the expectation of 175,000 new jobs. The July figure was revised higher to 194,000 from the initial report of 179,000. The data caused the Dollar to move higher but gains were not sustained. The Chicago PMI was reported at 51.5 against an expected 54.1, and the monthly pending homes sales were seen rising 1.3%, against an expected rise of 0.7%. Next on the economic calendar is quarterly private capital expenditures and monthly retail sales out of Australia at 21:30 EST.

Among the cross rates, a steady rally in AUD/JPY shows the pair back at its monthly opening price, erasing prior losses for the month. The pair is on track to post a second consecutive monthly doji. A recovery in GBP/AUD shows the pair back in the green for the month. The pair is likely to post a doji for the month, following sharp monthly declines dating back to the UK vote. AUD/NZD declined to fresh lows for the week today, the pair will likely close the month out at the lowest close since April 2015.

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Australian Manufacturing PMI (August): 46.9 (prior 56.4)

Australian Industry Group Performance of Manufacturing Index for August

• Huge drop, down 9.5 points on the month (biggest drop ever for this survey)
• After 13 months of expansion a plunge back into contraction

RBA: 'Lowe And Lower': What's Next For AUD?

The lower limits of RBA policy:

We think the RBA is likely to keep rates on hold when the board meets on 6 September.

This will be the last board meeting for Governor Glenn Stevens. The new Governor, Phillip Lowe, will take over on 18 September. The mildly pre-emptive rate cut last month took the official cash rate to a new record low of 1.50%. While inflation was in line with expectations, the Bank took the opportunity to bolster the growth outlook for 2017 when we expect more of a drag on growth from slower housing activity. It also gives the new Governor scope to resist pressure to cut rates again if 3Q inflation is weak.

We expect another cut in 1Q17, but the scope for further easing would be constrained if broader financial conditions ease before then. The scope for Lowe to use traditional monetary policy to respond to unexpected economic weakness is far more limited than was the case for his predecessors at the start of their terms (chart), although the downward shift to the left reflects the global low inflation and rate environment. The net benefit of further easing is now much more marginal.

Implication for FX:

The search for positive yield has become a catch-all phrase to explain the resilience of high-yielding assets globally. Nowhere is this more evident than the AUD and NZD, where despite the reduction of policy rates since July, both currencies have remained supported.

Looking ahead, the key question is how long these "carry inflows" can persist, even as the yield advantage compresses further. There is clearly risk that structural price-inelastic flows like the grab for duration by pension funds and potential diversification by central banks may stay firm. But marginal carry demand should nonetheless weaken as yield spreads narrow and FX strengthens. As both the RBA and RBNZ extend their easing cycles, yield-motivated arguments for buying FX are likely to become less compelling over time, especially if global volatility rises, potentially due to the upcoming US election.

In terms of drivers more specific to AUD, we are watching iron ore and steel prices closely. The resilience in these commodity prices over the past three months has supported the AUD but may be set to reverse in the coming months, especially if China data slow. Our commodity team expects iron ore prices to weaken to $45/t avg in 4Q as seasonal weakness and a second-half lift in low cost supply bites. Deterioration in terms of trade would heighten the pressure on AUD from broader risk reduction ahead of the US election. Given the crowded long positions in the AUD, we think it will be especially vulnerable in a risk unwind scenario driven by external factors. 

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AUD/USD forecast for the week of September 5, 2016

The AUD/USD pair went back and forth during the course of the week, ultimately settling on a fairly neutral candle. By doing so, the market looks as if it is still try to figure out what to do. I recognize that there is a lot of resistance above at the 0.7675 level, which continues to be a real thorn in the side of the buyers. With this, a break down below the bottom of the range for this past week would be very negative. Ultimately though, there is a lot of choppiness just waiting to happen in this pair.

Australian GDP Growth Forecast to Slow in Second Quarter; RBA To Hold Rates Steady

Australia’s economic expansion cooled in the second quarter. That’s the view of a broad consensus of market analysts, including central bank economists, who believe that Australian Q2 GDP growth will be a fraction of the pace seen in the first quarter.

The combination of weak business investment, rising imports and a slowdown in export growth are expected to limit GDP growth to just 0.4% in the June quarter. That’s down sharply from the 1.1% expansion seen in the first three months, which was also the highest in three years.

Even with a 0.4% increase, annualized GDP growth would still reach 3.2%, which is above-trend and slightly higher than 3.1% in the first quarter.

The Australian Bureau of Statistics will release its preliminary Q2 GDP estimate Wednesday at 11:30 am AEST.

According to ANZ, an expansion in Q2 would mark Australia’s 100th consecutive quarter without recession. A technical recession is defined as two consecutive quarters of negative growth.

The economy is being supported by robust consumer spending and a solid housing sector. Exports have played a major role thanks to a weaker domestic currency. The Australian dollar has made a comeback over the last three months, rising 4.5% against its US counterpart. However, over the past two years, the Aussie has weakened by more than 18%. Going back five years, the Australian dollar has lost nearly one-third of its value against the greenback.

The Reserve Bank of Australia (RBA) has also taken preemptive measures to ensure that sluggish inflation doesn’t drag on growth, including slashing interest rates on two occasions earlier this year. The RBA lowered its official cash rate by 25 basis points to 1.5% at its August meeting, a move that was widely predicted by the market. The decision came after the government’s consumer price index (CPI) confirmed that annualized inflation fell to 1% in the June quarter, its lowest level in 17 years.

The RBA will deliver its next interest rate verdict on Tuesday. Policymakers are widely expected to keep the overnight rate steady following the latest flurry of economic data, particularly in the housing market.

The RBA’s rate announcement on Tuesday will be the last headed by retiring governor Glenn Stevens. Beginning in September, the RBA will be led by current deputy governor Philip Lowe. Markets shouldn’t expect a major shift in policy under the new central bank chief. However, Lowe will probably face greater scrutiny than Stevens should the Bank decide to lower rates again.

Under Stevens’ ten-year administration, the RBA hiked interest rates up to 7.25% before bringing them back down tot he present low.

Australia - Services PMI for August: 45.0 (prior 53.9)

• Big slide lower for the services PMI, the biggest drop ever for this index
• All of the five subindices fell in the month

• Sales down a whopping 15.7 points to 43.7 (now at its lowest since December 2015)
• New orders down 4.7 to 47.5
• Employment 43.5, down -6.5 (to its lowest since April 2009)
• Wages up 3.6 points to 52.9
• Input costs  up 4.6 to 59.9
• Selling prices 43.3 ( down 9.1)

The Reserve Bank of Australia Board meeting today

• There is little expectation of any change to the cash rate
• Eyes are on the accompanying statement for the outlook (there are some expectations of a November cut, and markets are pricing in a 25bp cut sometime in the next 12 months)

• We are confident that there will be no move coming from this meeting
• The more interesting issue is whether the Board cuts rates at its meeting on November 1

• Global developments are also expected contain the need for lower rates
• We expect that the Federal Reserve is on track to raise the Federal funds rate in December
• Higher US rates are likely to reduce the need to take upward pressure off the AUD with an RBA rate cut
• We also expect that commodity prices will be falling under the weight of rising supply and reduced underlying demand from China lowering the AUD's fair value
• Uncertainty around the US election result (November 8)
• We do not expect any disturbing developments in the real economy
• June quarter GDP is likely to show growth of 0.4%, lifting annual growth to 3.2%
• Our lead indicators for the labour market signal jobs growth consistent with falling unemployment