AUD outlook remains poor; central bank puts in play

Door remains open for AUDUSD to trade lower towards 0.65. Central bank puts are coming into play.
Philip Wee, Duncan Tan13 Jun 2019
    Photo credit: AFP Photo

    FX: Still-poor AUD outlook

    The Australian dollar has tried and failed to appreciate above 0.70 against the USD. It has since retreated to 0.69, its lowest level since May 30. Although US nonfarm payrolls for May came in lower at 75k vs the 175k consensus, the US unemployment rate was unchanged at its record low 3.6%. This will not be enough for the Fed to bring lower the Fed Funds Rate at the FOMC meeting June 19.

    The rise in Australia’s jobless rate to an eight-month high of 5.2% was, on the other hand, reason enough for the Reserve Bank of Australia to axe, on June 4, its cash rate target by 25 bps to a new lifetime low of 1.25%. Another disappointing reading today would keep expectations open for another easing. The 2Y AU government bond yield has, after the RBA cut, continued to fall to 1.05% from 1.12%.

    The Oz is good example of the relative strength of the greenback. Real GDP expanded 1.8% YoY in 1Q19, its first sub-2% growth since 2Q13. US growth has stayed at/above 3% for three straight quarters into 1Q19. Australia’s inflation (1Q19: 1.3% YoY) is farther below 2% compared to the US (May19: 1.8%). This picture is unlikely to improve anytime soon given the threat of more US tariffs on Chinese goods. Hence, the door remains open for AUDUSD to trade lower towards 0.65.

    Rates: Central Bank Puts

    The central bank puts are starting to knock in. Responding to a deteriorating global economic outlook and rising event risks (largely from US trade policy), key Fed/ECB/BOJ/PBOC officials have lately spoken of their readiness and the room to step up on monetary accommodation. Possible measures mentioned include liquidity injection, funding support, interest rates cut and restarting QE. Collectively, the threshold to deviate from a “patient”, wait-and-see approach appears to be declining. It is fair to say that markets have been pricing for this in the months prior.

    Interest rate indicators are flashing red, and when viewed in isolation, seem to be signalling adverse future economic scenarios. The much watched 3M10Y UST spread (seen as a harbinger of recession) has been inverted for 21 straight days and counting (10 days is commonly seen as a significant threshold). Pricing of Fed cuts through end-2020 have climbed to around 100bps (that is almost half of the policy room before we hit the Fed’s “effective lower bound” of 0%). However, when we look at other asset classes, markets seem to be quite sanguine about the outlook. In Equities, S&P 500 Index is just 3% off all-time highs and related volatility measures (VIX and VVIX) are low. In Credit, USD and EUR high-yield credit spreads are tightening again in June (after widening in April-May). Current spreads are nowhere near levels typically associated with elevated recession risks. In FX, Emerging Markets currencies (fundamentally levered to global growth outlook) are broadly weaker year-to-date but the extent has been rather modest, with the exception of idiosyncratic cases like ARS and TRY. For a more comprehensive perspective, do check out our Global Macro Risk Dashboard (link)

    One way to link all of this is that markets expect major central banks to step in to support growth, cushion downside risks and effectively engineer a soft landing. In recent weeks, we are certainly seeing increasing frequency of the phenomenon of bad trade/economic news being good news for asset prices (because it is perceived to increase the chances of central banks stimulus).

    Philip Wee

    FX Strategist - G3 & Asia

    Duncan Tan

    FX and Rates Strategist - Asean


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