The Australian Dollar has suffered fresh declines as new data concerning wage growth comes in softer than expected, however, we here that there are limits to the currency's weakeness.
- Wages rose just 0.4% q/q and 2.1% y/y – on both measures growth is the slowest on record
- Aussie dollar was stronger 24 hours earlier, seen recovering from oversold conditions and RBA minutes release
- ABN Amro's Roy Teo on why recent declines could give way to a return to strength
The Australian dollar is in decline once again and is retracing the gains realised following the release of the Reserve Bank of Australia (RBA) minutes to the May meeting - the same meeting in which decision-makers cut interest rates.
The wage price index rose just 2.1% y/y in the first quarter of 2016, the lowest rate on record in this series reflecting both domestic and global factors.
Indeed, while unemployment remains elevated in Australia, even in those economies at, or close to, full employment wage growth has remained low.
The pound to Australian dollar exchange rate (GBP/AUD) rose following the new and was seen at 1.9841 - the best level since late February for those looking to purchase AUD.
The Australian to US dollar exchange rate (AUD/USD) fell 0.7% to 0.7274 and appears intent on testing the May lows towards 0.7250.
"We expect wages growth to remain soft over the next year or so, which will keep inflation low, while also remaining as a headwind to household spending," says Felicity Emmett at ANZ Research.
In its recent inflation forecast downgrade, the Reserve Bank of Australia (RBA) clearly reassessed its view on the wages outlook.
Tuesday’s release of the May policy meeting's minutes noted that “the forecasts embodied the expectation that growth in the wage price index would stabilise around current quarterly growth rates before gradually picking up later in the forecast period”.
On that front, these wage price numbers look to be marginally weaker than the Bank’s expectations.
The focus of the minutes was around the Bank’s downgraded inflation forecasts.
The minutes highlight the Bank’s uncertainty over the inflation outlook, and its concerns about the second-round impact of lower inflation on wages growth.
The AUD rallied as markets read that there was little observable evidence that further big cuts were coming and the Australian dollar embarked on a relief rally in response.
However, there were warnings that strength would likely be short-lived.
"Don’t read too much into the lack of an explicit easing bias in the minutes. This is normally the case in the press release and minutes following a rate cut. We continue to expect another cut at the August meeting," said ANZ's Emmett.
We would expect Australian dollar gains to be limited in light of this threat and keenly await the next set of inflation data at the end of May.
Still Betting on Gains
The Aussie has fallen over 7.5% from its 0.7823 peak on April 21 to is current level in the upper 0.72s, and yet a recent report shows speculators are still carrying a net positive balance of long futures positions.
‘Long’ positions are the same as ‘buy’ positions, and are opened to make a profit if the asset rises.
Although net long positions (long minus short) fell to 38k in the week ending May 10, from 52k in the previous week, they nevertheless remain positive despite the strong sell-off in the underlying exchange rate.
The graph below clearly shows in pictorial form the relatively high number of net long positions in the Australian Dollar, in the weekly CFTC (Commodity Futures Traders Commission) data from US exchanges.
It also shows historical extremes represented by the black outline of the bar above and below the blue and red representing the current net long and short positioning.
Australia’s fundamentals have worsened in recent weeks, after a shock drop in inflation prompted the Reserve Bank of Australia to cut interest rates to 1.75% from 2.0% previously.
A further blow to the economy and inflation expectations has been the fall in the price of Iron Ore, the country’s second largest export.
The price had strengthened very rapidly to above $60 per barrel, due in major part to speculative trading alone, with data showing that speculative buying on one volatile day on the Chinese Dalian Exchange accounted for more volume that China’s entire Iron ore imports in a whole year.
The price, however, recently slid 8% in May to $55 per barrel, after the Chinese authorities introduced new regulations on Chinese Futures Exchanges to curb speculative trading.
The high number of long contracts, raises the possibility of more weakness as traders still long the aussie unburden themselves of their losing positions.
Downside limited according to Abn Amro
Another possibility, however, is that speculators are hanging onto their longs becuase the expect more upside.
This is the stance of Dutch lender Abn Amro in their recent research note on AUD:
“We think there is limited room for further Australian dollar (AUD) weakness and expect the currency to find some support above 0.70 versus the dollar this year. In our view, the Reserve Bank of Australia (RBA) is likely to cut the Official Cash Rate (OCR) by 25bp to 1.5% later this year in August. However, this is almost fully priced in.” Suggests the notes author, Roy Teo, Senior FX Strategist at Abn Amro.
Teo thinks an earlier rate cut at the RBA’s June meeting is unlikely as it would be “back-to-back” with the cut in April (notwithstanding a data shock).
“As a result, the AUD may recover to around 0.73 (previous forecast 0.76) as financial markets are pricing in about 25% probability of 25bp rate cut at the next monetary policy meeting on 7 June. However we expect any gains in the AUD to prove temporary as the RBA is likely to maintain a dovish stance. “
Abn Amro also allude to the continued large positive net long position in the currency as providing potential ‘supply’:
“In addition there is room for further liquidation of net long AUD speculators’ positions given the RBA’s monetary easing bias. Hence the AUD is likely to ease lower to around 0.72 (previous forecast 0.76) in the third quarter.”
Abn then see the rise extending to 0.74 later in the year as the RBA stays on hold and the Federal Reserve also keeps rates unchanged throughout 2016.
They see higher gains capped by RBA intervention to keep the AUD supportive of exports. It is still overvalued according to the price of commodities argues Teo so the RBA will not tolerate it strengthening any higher.
Then in 2017 they see the AUD at 0.75, with the dollar boosted by 0.75% of interest rate rises and the Aussie supported by no more RBA cuts.
Chinese Data Undermines Australia's Dollar at Start of Week
A string of Chinese data released at the turn of the week disappointed investor expectations with Industrial Production coming in at 6.0% versus 6.5% eyed while Retail Sales printed at 10.1% versus 10.5% projected.
The Aussie hit a ten week low on the news, dropping to 0.7244 against the dollar at the start of Asian trade, but the pair found some bargain hunters at that level and short covering drove it up above the 0.7300 figure by start of European trade.
"Still the weakness in Chinese data is clear sign that the economy in Asia is continuing to slow and may in fact be getting worse as we move into the summer months. Those macro factors are likely to weigh heavy on AUD/USD which is the favorite proxy for Chinese growth in the financial markets and the pair could easily drift to 7000 and below as the summer progresses," says Boris Schlossberg at BK Asset Management in New York.