Australian Dollar: Growth and Yield Demand Dependent Upon China

Australian Dollar: Growth and Yield Demand Dependent Upon China

Fundamental Outlook for US Dollar: Bearish

-The Australian employment change misses its forecast and the unemployment rate climbs

-Home loans drop in June as the economy feels the latent effects of the RBA’s hawkish regime

-AUDUSD reverses alongside EURUSD, but will the commodity cross maintain its new bearing?

The Australian dollar is still one of the highest-yielding liquid currencies in the FX market and it is backed by an economy that has consistently outperformed its developed counterparts. That being said, the currency has little going for it through the foreseeable future. Speculators are not concerned with current conditions as they are already priced in. The outlook for risk and return is what guides every asset. On these terms, the market doubts that the Reserve Bank of Australia will even hike rates a quarter-percent even once over the coming year. What’s more, the current level of interest rates is already stifling activity while the global economy cools. With these concerns in mind, Aussie dollar traders head into the week fully dependent on risk appetite trends. Should pessimism rear, the already-exposed currency will find itself exposed to further depreciation as the speculative crowd works off latent premium.

It is true that the Australian economy has an exceptionally high rate of return on its assets due to the high benchmark rate which is further a factor of an exceptionally health economy. However, where does this strength come from? It is true that Australia’s domestic consumption is relatively stable and financial exposure is modest compared to many others. Yet, it is often overlooked that the continents strength is heavily supported by seemingly endless demand from China. However, this engine of growth is not everlasting. In fact, we have already seen signs that the government is taking steps to preempt an asset bubble or lending market collapse. Over the past weeks, we have seen the nation’s banking regulator raise capital reserve requirements, require stress tests for a scenario accounting for a 60 percent drop in housing prices and force banks to move off-balance-sheet liabilities onto their books. This has the cumulative effect of draining liquidity from the market and removes an important safety net just as the next financial disturbance approaches. Even if this is a composed slow down, the economic impact on Australia will be substantial as it supplies the raw materials and energy for expansion. Should the effort turn into a crisis, the Australian dollar will be hit by the economic impact as well as a tidal wave of risk aversion.

While China poses a prominent threat to the Australian dollar; it will be a slow motion crash until the government takes additional steps towards curbing activity, global investor sentiment slumps or the local market finally collapses on itself. In the meantime, there is scheduled data that represents a known danger of volatility. The Westpac Leading Index will be a good, all-encompassing reading for economic activity. Adding to speculation for next month’s 2Q GDP reading, the CBAHIA housing affordability index and wage cost indexes for the same period are second tier releases. The top scheduled event risk for the period is the RBA’s minutes from its last policy meeting. The central bank didn’t change its benchmark rate; but insight into growth, inflation and financial stability trends are vital to interest rate speculation. - JK