New drivers at the wheel for the AUD – Deutsche Bank

Tim Baker, Strategist at Deutsche Bank points out that the AUD has performed strongly in 2017, easily beating consensus expectations (which had AUD/USD at 73c now, rather than 79c).

Key Quotes

“For much of the year key drivers have been the weak USD and strong risk sentiment (reflected in EM equities) – they’ve had correlations of 50%+ with AUD. But these drivers have faded of late, giving way to the iron ore price and rate differentials, which have risen in importance.” 

“Support from iron ore/China is likely to continue. While last week’s IP and FAI data was on the soft side, lead indicators sit at six-year highs. Further, July credit growth beat expectations and overall monetary conditions haven’t tightened much – they don’t point to any commodity price downside. Even the IMF has gained more comfort with credit-fuelled growth, upgrading its forecasts last week. The supply side is likely to weigh later in the year – the majors are ramping up iron ore production, and swing supply is likely to be enticed back (China’s production has been flat – that will likely change). But in the near-term conditions look favourable.” 

“Moves in rate differentials have helped the AUD as well – RBA pricing has swung from a cut to a hike on the back of RBA’s neutral rate talk and strong jobs data (as well as the familiar story of elusive US inflation US). We think this story is overdone - the wage growth cycle in Australia looks well behind the US, with relative wage growth pointing to lower AUD next year. But next year’s a long way away – it’s not clear what dislodges this story any time soon.” 

“Where does that leave us? As dull as it sounds, it’s a currency that likely stays in the recent range. The 80c level could easily be breached again (perhaps on US debt ceiling fears), but we’d fade that move given the drag it exerts on the economy (noting the RBA has expressed concern). On the downside, it’s hard to see a break below 78c until there’s a meaningful change in the commodity/China story.”