27 Mar 2014
Downside risks for the AUD are building - Westpac
FXStreet (Bali) - Downside risks for the A$ are building, notes Robert Rennie, FX Strategist at Westpac.
Key Quotes
"Our attitude towards the AUD is shifting. The wall of worry the A$ will need to climb is getting higher. We have had multiple waves of financial market squeezes in China in 7 day repo, CNY and CNH; we have had the first corporate bond default in China; the atmospherics surrounding iron ore have deteriorated sharply; rebar prices made fresh lows back to 2007 in the last 24 hours. None of this bodes well for the A$ near term."
"On top of this, we noted last week shipping indices have been warning about softer activity in bulk shipping. Our measure of bulk shipping activity has started to slow more clearly too. In other words, if this continues, we should expect to see further signs of softer trade in the weeks and months ahead."
"However, it's not just China/ steel/ iron ore that concerns us. Coal prices have weakened too. Australia's export commodity basket continues to trend lower. This suggests downside risks for the terms of trade over the coming 3-6 months, as our commodity price index tends to lead terms of trade moves over this timeframe. Hence there is a risk that terms of trade rolls back over for the first half of 2014. This will tend to weigh on nominal GDP growth, all else equal."
"The relationship between our commodity price index and the AUD performance against the rest of the G7 is by no means perfect but the broad trends in both series tend to follow each other the medium term. The AUD still has some catch up to downside given the recent fall in the commodity price index. Arguably the divergence between these two series should correct over the medium term, which continues to suggest a sell on rallies approach for the AUD."
"One reason the AUD is trading quiet resiliently to the recent commodity sell off is the fact that the current correlations with the AUD are actually quite low. The chart below plots the rolling 3 month correlations between AUD and commodity prices, the yield differential and global equity market performance (based off weekly changes)."
The current correlations suggest a reasonable relationship between AUD and the yield differential. The correlations with commodities and global equity market performance are quite low. Correlations can of course rise from these depressed levels but in the near term a weaker AUD story may only materialise if the yield differential moves against the currency.
"In addition to the above, yield momentum is moving against the A$. Part of this story is the volatile uptrend in US yields of late and the prospects of more taper at coming meetings; part of it is the domestic market which can't price in too much more on the RBA. "
Key Quotes
"Our attitude towards the AUD is shifting. The wall of worry the A$ will need to climb is getting higher. We have had multiple waves of financial market squeezes in China in 7 day repo, CNY and CNH; we have had the first corporate bond default in China; the atmospherics surrounding iron ore have deteriorated sharply; rebar prices made fresh lows back to 2007 in the last 24 hours. None of this bodes well for the A$ near term."
"On top of this, we noted last week shipping indices have been warning about softer activity in bulk shipping. Our measure of bulk shipping activity has started to slow more clearly too. In other words, if this continues, we should expect to see further signs of softer trade in the weeks and months ahead."
"However, it's not just China/ steel/ iron ore that concerns us. Coal prices have weakened too. Australia's export commodity basket continues to trend lower. This suggests downside risks for the terms of trade over the coming 3-6 months, as our commodity price index tends to lead terms of trade moves over this timeframe. Hence there is a risk that terms of trade rolls back over for the first half of 2014. This will tend to weigh on nominal GDP growth, all else equal."
"The relationship between our commodity price index and the AUD performance against the rest of the G7 is by no means perfect but the broad trends in both series tend to follow each other the medium term. The AUD still has some catch up to downside given the recent fall in the commodity price index. Arguably the divergence between these two series should correct over the medium term, which continues to suggest a sell on rallies approach for the AUD."
"One reason the AUD is trading quiet resiliently to the recent commodity sell off is the fact that the current correlations with the AUD are actually quite low. The chart below plots the rolling 3 month correlations between AUD and commodity prices, the yield differential and global equity market performance (based off weekly changes)."
The current correlations suggest a reasonable relationship between AUD and the yield differential. The correlations with commodities and global equity market performance are quite low. Correlations can of course rise from these depressed levels but in the near term a weaker AUD story may only materialise if the yield differential moves against the currency.
"In addition to the above, yield momentum is moving against the A$. Part of this story is the volatile uptrend in US yields of late and the prospects of more taper at coming meetings; part of it is the domestic market which can't price in too much more on the RBA. "