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Australian Dollar Fundamental Outlook: RBA Pauses with CPI Ahead

Australian Dollar Fundamental Outlook: RBA Pauses with CPI Ahead

Daniel McCarthy, Strategist

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Australian Dollar Fundamental Outlook: RBA Pauses with CPI Ahead

The Australian Dollar finished the first quarter not far from where it started after trading in a wide range of 0.6565 – 0.7158 through the first three months of 2023.

It initially ran to the early February peak on the back of US Dollar weakness. When the greenback turned around and strengthened, AUD/USD visited the mid-March low of the quarter.

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Monetary Policy Matters

All this price action was led by perceptions of what the Federal Reserve had planned for their rate path. Going into the end of the first quarter, the banking crisis began to unfold. The Fed is left with the dilemma of fighting inflation while not smoking the financial system. This dichotomy has the potential to be a driving force for the Aussie Dollar going forward.

It is important to note that there are two types of issues unfolding for failing banks. Firstly, there are those banks that have had weak balance sheets for some time and have been exposed to the tightening of monetary conditions. Secondly, there are banks that have mismanaged their balance sheet by having a mismatch of assets to liabilities.

Credit Suisse and Republic Bank fall into the former category, while Siilvergate Bank, SVB Financial and Signature Bank belong in the latter category.

Overall, this might suggest that the problems are not systemic per se, but that more banks could be exposed for failing in either category through the second quarter. Corporates that have weak balance sheets and need to go back to the market to raise capital might also find tough conditions for doing so.

With this in mind, AUD/USD is viewed by the market as a high beta currency making it more susceptible to sways in investor and risk sentiment than other major currencies.

If the banking upheaval continues, then financial conditions could further tighten, and this may see confidence in global markets undermined. This environment might see AUD come under pressure.

Conversely, if conditions stabilise, then the focus could return to how hawkish the Fed will need to be to get inflation down to its target of 2% from the last read of 6% year-on-year to the end of February.

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Easy Does it for the RBA

Domestically, the RBA have played their hand and backed away from further tightening according to the April monetary policy meeting minutes. First quarter CPI will be released the day after ANZAC day on April 26th. The RBA has cited the slowing in the monthly inflation gauge as re-assuring their dovish posture. The more accurate quarterly figure will be closely watched to see if they are off the hook or not.

The RBA has raised the cash rate by 350 basis points since last May 2022. In October 2021 the Australian Prudential Regulation Authority (APRA) released this statement.

“APRA has told lenders it expects they will assess new borrowers’ ability to meet their loan repayments at an interest rate that is at least 3.0 percentage points above the loan product rate.”

Much has been made of the so-called ‘mortgage cliff’ where borrowers will need to refinance their debt of the last few years at current levels. These debts appear to be at the upper end of APRA’s expectation of appropriate lending. This might go some way to explain why the RBA is hesitating to tighten monetary policy while CPI remains much higher than its target of 2–3%.

All of this stacks up to potential headwinds for the Australian Dollar. The bright side is that a low exchange rate contributes to the trade surplus that continues to deliver prosperity to the local economy. It is consistently running at over AUD 10 billion a month.

Meanwhile, bond spreads continue to play a role in the background and could be a contributing factor for AUD/USD should there be a large move in the spreads.

AUD/USD Against AU-US 3 and10 Year Bond Spread

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Chart prepared by Dan McCarthy using TradingView

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--- Written by Daniel McCarthy, Strategist for DailyFX.com

Please contact Daniel via @DanMcCathyFX on Twitter

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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