AUD goes for gold – Westpac

Sean Callow, Research Analyst at Westpac, suggests that the last time the Australian dollar was this strong was just before the stunningly low Australian Q1 CPI report.

Key Quotes

“The report of course jolted the RBA into slashing its inflation forecasts in May and cutting the cash rate for the first time in a year. The Aug rate cut to 1.5% was not accompanied by major forecast changes and can be seen as the second installment of the policy response to a clear step lower in Australian inflation. The RBA now sees inflation not rising above 2% y/y (the bottom end of its target band) through end-2018.

Having delivered 50bp of easing in 3 months and with the economy still looking to be maintaining a growth pace near 3% y/y, there is no compelling case for the RBA to cut rates again near term. Indeed markets price only a 15% chance of a move at either of the Sep or Oct meetings. This takes a little pressure off AUD for now. Yet markets will continue to price in a substantial risk of further RBA easing at some point, whereas the Fed’s next move is still likely to be a hike. As the chart shows, the 2 year AUD yield premium over USD has fallen about 25bp since June but AUD/USD has rallied sharply, suggesting AUD is becoming pricey.

Commodity prices (notably iron ore and coal) are offering AUD support, even if the multi-month outlook is for growing supply to weigh on Australia’s key export prices. Positive risk appetite (fresh record highs on the S&P 500) encourages inflows to Asian currencies (KRW and TWD especially strong this month) and thus the AUD vibe.

This all adds to the bullish mood on AUD/USD near term. The strong US July jobs data wasn’t enough for markets to be serious about a Fed hike in Sep or even Dec. Until this mood changes, the Aussie seems on track to re-test the April highs above 0.78. But don’t forget what happened next!”