Market more confident of a hike from RBA - Rabobank
Analysts at Rabobank explained that it is clear that the most recent moves on AUD/USD have been heavily biased by the general tone of the greenback.
Key Quotes:
"The USD has found some renewed support in recent sessions having been under pressure since early December. That said, measured on a 1 mth view the AUD can claim to be the second best performing G10 currency after the NZD. This has been a function of a December surge in expectations regarding the chances of an RBA rate hike in 2018 and a recovery in the price of Australia’s key exports of coal and iron ore.
There is currently a confusing array of forecasts in the market about the prospects for iron ore this year. This week the Australian government projected a sharp decline in iron ore prices from 2017 on the back of rising global supply and moderating demand from China. Several private sector forecasters, however, remain far more optimistic on the outlook for prices. Part of the confusion with respect to the outlook for iron ore demand lies with the closure of some of China’s most polluting steel plants. The government has implemented a stringent anti-pollution policy in Beijing, Tianjin and 26 other cities, closing cement and steel plants or suspending or curtailing production. There has been a complex series of knock on effects from this policy. Steel production in other parts of the world has been given a reprieve from the impact of China’s dominance in the sector, though strong world growth has also been a contributing factor to this. China’s clampdown on pollution has also led to higher demand for the least polluting iron ore products with a significant spread opening up between high and low grade iron ore. While a widened spread between grades could be permanent given China’s commitment to improve air quality, counter to the government’s view, there is currently a fair degree of optimism amongst some parties that prices of iron ore in general will surge into the spring. This is because China’s winter production restrictions will be eased as warmer weather returns before they are re-applied towards the end of the year.
Also, contributing the uncertainty about how much iron ore China will demand this year, is the range of forecasts for world steel supply this year. According to FT research, market forecasts for annual steel production are mainly spread in the 0 to 4% y/y area, with forecasts for growth in production in China being on the low side compared with Europe and the US. Growth in US supply of steel, however, is unlikely to benefit Australian iron ore producers since N. America imports very little ore. The Australian government expects growth in its country’s iron ore exports volumes to moderate to 1.6% y/y in the year starting July 2018. This compares with growth of 4.2% y/y in Q4 2017. It is forecasting iron ore prices to continue dropping through into 2019 on the back of growing low-cost supply from both Australia and Brazil in addition to moderating demand from China. In 2015, China absorbed over 60% of all iron ore imports. The government is also pessimistic about the outlook for coking and thermal coal prices.
While not all commodity forecasters are in agreement with the Australian government, slowing Chinese demand for iron ore and coking coal and a softening in the price for the commodities would clearly not be supportive factors for the AUD. That said, the Australian government is more optimistic about growth in liquefied natural gas (LNG) forecasting that it will add AYD14 bln to Australia export earnings between 2016/17 and 2018/19 while iron ore could subtract AUD10 bln.
The risk of reduced Chinese demand for Australia’s bulk exports is likely to strike a note of caution at the RBA. That said, the domestic economy and in particular the labour market has been showing stronger signs. The minutes of the December RBA meeting report that “labour market conditions had remained positive and had been stronger than expected over the previous year. Employment had increased a little in October and growth over the previous year had been well above average. Full-time employment had risen sharply and was growing at around its fastest pace in a decade.” This policy meeting took place ahead of the release of the far better than expected November labour report which showed a 61.6K surge in employment, mostly in full time jobs.
The strength of the November Labour report has not changed the fact that last year, Australian wage growth hit its lowest levels on record. The slow growth in household incomes and high levels of debt remain a considerable cause for concern for the RBA. This suggests that there is no pressing need for interest rates to change. That said, last month the RBA did conclude that “over the prior year or so, the unemployment rate had fallen and inflation had moved closer to target”. It also stated that “recent data had increased confidence that there would be further progress on these fronts over the following year.” Although the central bank is data dependent, the market is more confident of a rate rise from the RBA this year, with August being cited more frequently as a potential date for a move. The growth in the market implied probability of a move was instrumental in leading the value of the AUD higher during December. If AUD/USD is to progress further, the next round of domestic economic data releases will have to be sound. Forthcoming release include retail sales consumer confidence and the December labour market report due on January 18.
In recognition of the improvement in domestic economic data and the market’s expectations regarding rate hike rises, we have revised up our forecasts for AUD/USD. However, with wage inflation low and given the potential for slowing Chinese demand for bulk commodities, we retain a relatively cautious medium-term view on the AUD vs. the USD. While we see scope for a fairly flat range for AUD/USD through the coming 6 to 8 mth, we continue to see scope for a softer AUD/USD into year end. Our 12 mth forecast stands at 0.75."