Australian Dollar Outlook Hinges on ECB Meeting, China News-FlowAustralian Dollar Outlook Hinges on ECB Meeting, China News-Flow

Fundamental Forecast for the Australian Dollar: Neutral

  • Aussie Dollar looks to ECB as driver of risk trends for direction
  • China NPC news-flow may impact RBA monetary policy outlook
  • Are FXCM traders buying or selling AUD/USD? Find out here!

The Australian Dollar enjoyed the sharpest rally in over four years last week, rising to the highest level since July of last year against its US counterpart. Domestic catalysts set off the move. First, the RBA opted for a neutral tone, disappointing the markets’ dovish expectations. Next, fourth-quarter GDP figures soared past consensus forecasts. Taken together, these outcomes weighed heavily against near-term rate cut speculation. A recovery in risk appetite was likewise helpful for the sentiment-linked currency as the MSCI World Stock Index rose to highest level in two months.

External forces are likely to recapture the spotlight from here, with central bank policy still the top theme to watch. The MSCI World Stock Index – a proxy for global risk appetite trends – has closely tracked global liquidity trends. Not surprisingly, this makes for an environment where stimulus expansion by the world’s top central banks triggers “risk-on” dynamics that benefit shares and high-yielding FX alike. Needless to say, policy tightening has the opposite effect. Indeed, global share prices carved out a top and began trending lower in 2014-15 as the Fed would down QE asset purchases and laid the foundation for interest rate hikes.

In the week ahead, this means the ECB monetary policy announcement takes top billing. While the markets have been primed for some form of stimulus expansion, the announcement’s impact will heavily depend on how Mario Draghi and company opt to deliver accommodation. Extending the existing €60 billion/month QE effort and pushing deposit rates deeper into negative territory clearly underwhelmed investors in December. The move brought policy rates in line with a drop in borrowing costs already priced in by the markets while offering no up-front boost to asset purchases.

This time around, investors are front-running a deposit rate cut once again. Assuming recent trends in spread between the EONIA benchmark for EUR-based overnight borrowing costs and the ECB deposit rate, the markets envision a 12 basis point cut this month. If the ECB does not meaningfully exceed their expectations and offer a tangible boost to the size of current QE provision, another disappointment is likely. Such a result will probably drag the Australian Dollar lower alongside stock prices. On the other hand, a bold move on both fronts will probably deliver the opposite result.

News-flow from China’s National People’s Congress will also be important. Beijing pre-announced a lower GDP growth target, setting a range of 6.5 to 7 percent as the objective. Premier Li Keqiang likewise offered broad outlines of a broad range of initiatives. The most directly significant items for Australia seem to be efforts to cut over-capacity in coal and steel, both of which are central to the country’s China-oriented mining industry. Details on this and a host of other policy changes will be closely watched for their knock-on effects on Australian growth and, by extension, on RBA policy trends.

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