Aussie Dollar Volatility Seen on China, US, Eurozone Event RiskAussie Dollar Volatility Seen on China, US, Eurozone Event Risk

Fundamental Forecast for the Australian Dollar: Neutral

  • Australian Dollar Continues to Face China-Driven Risk Aversion Threat
  • Upbeat Jobs Data May Trim RBA Rate Cut Outlook, Cap Aussie Losses
  • Find Critical Turning Points for the Australian Dollar with DailyFX SSI

The Australian Dollar dropped to finish last week at the lowest levels in nearly seven years as aggressive risk aversion battered the sentiment-linked currency. The S&P 500 – a benchmark for market-wide risk appetite – fell for a second consecutive week to record the largest such losing streak since November 2011. Commodity prices also continued to sink, with a host of aggregate benchmarks of raw materials prices sinking to multi-year lows.The week ahead offers ample opportunities for the rout to continue.

China is due to report fourth-quarter GDP figures on Tuesday, with the year-on-year growth rate expected to remain unchanged at 6.9 percent. Broadly speaking, Chinese economic growth has been decelerating since 2010. As performance soured, capital flowed out of China and put downward pressure on the Yuan. Beijing began spending FX reserves to fight depreciation in mid-2014 in a show stability meant to bolster a bid for CNY to join the IMF’s SDR reserve currency basket.

This continued until August of last year, when officials announced a large one-off devaluation and changed the process for setting the official CNY exchange rate. This spooked China’s speculatively-minded equity markets, sending prices sharply lower. Needless to say, adding wild market gyrations to slowing growth did nothing to improve capital flight. Rather, it was amplified. Indeed, China has had to continue to pour FX reserves into fighting Yuan depreciation despite having changed the rate-setting regime just to manage the velocity of the move. This precarious situation has not gone unnoticed in the broader financial markets, with Chinese news-flow emerging as a key risk aversion trigger once again at the start of 2016.

With this in mind, the fourth-quarter GDP print has significant market-moving potential. Recent Chinese data has outperformed relative to consensus forecasts, suggesting analysts’ models may be under-stating the economy’s vigor. That opens the door for an upside surprise that speaks directly to where China-inspired negative sentiment originates. Such a result may bolster sentiment, helping to engineer a corrective recovery for the Aussie Dollar.

Aside from China, comparative monetary policy bets remain a key source of volatility. December’s US CPI report is expected to show the core year-on-year inflation rate rose to a three-year high of 2.1 percent. That may stoke bets on a more aggressive Fed rate hike cycle, an outcome that could swiftly cap any nascent recovery in risk appetite. On the other side of the spectrum, a monetary policy announcement from the ECB could prove to be supportive. Traders interpreted the latest round of disappointing German and Eurozone-wide price growth figures to mean the central bank may have to expand stimulus efforts. Clues alluding to as much from ECB President Mario Draghi may brighten investors’ mood.

As risk sentiment shifts to these potentially conflicting developments, so too will the Aussie. Indeed, the correlation between the S&P 500 and AUDUSD is now a hefty 0.985 on rolling 20-day studies. This opens the door for another week of sharp volatility.