AUD: Bearish signals – Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that AUD has been undermined by a plunge in the price of iron ore this month and some uncertainty about the strength of economic growth in China going forward

Key Quotes

“Speaking yesterday RBA Governor Lowe indicated that a rise in global interest rates “has no automatic implications for Australia”.  

 “Having dropped sharply on September 20, AUD/USD continued its downside bias yesterday in response to Lows’ speech.  This morning AUD/USD has consolidated close to the week’s softest levels. This week’s confirmation from the Fed that it remains committed to its policy tightening and the more sanguine view on policy implied by Lowe has opened the AUD/USD up to pressure from interest rate differentials.  Lowe spoke about the weakness in wages, stating that “over the past four years, the increase in average hourly earnings has been the slowest since at least the mid-1960s.”  He said that “this is partly a consequence of the unwinding of the mining boom but there are structural factors at work as well. The slow growth in wages is putting a strain on household budgets and contributing to low rates of inflation”.”

“Even though the US is subject to the same conundrum related to the lack of wage pressures being generated by healthy employment numbers, the FOMC currently appear to be prepared to shrug this off (though ultimately we expect the Fed to bow out of another rate hike this year).  In addition to a negative impact from interest rate differentials, the AUD has also been undermined by a plunge in the price of iron ore this month and some uncertainty about the strength of economic growth in China going forward.”

“Meanwhile, yesterday’s downgrade of China’s long-term sovereign credit rate to A+ from AA- by S&P Global Ratings has brought back to the fore concerns about financial risks in the country.  S&P warned that “China’s prolonged period of strong credit growth has increased its economic and financial risks.”  

“The S&P announcement clearly comes at a sensitive time for China given next month’s important political Congress.  China’s Finance Ministry today retorted that S&P has ignored the country’s sound economic fundamentals and that the government capable of maintaining financial stability if it strengthens supervision and controls.  However, S&P’s concerns do echo views already widespread in the market related to the build-up of debt and associated level of unproductive capacity.  Assuming China does strengthen its controls over credit creations, Chinese growth could slow and this is a risk for all China’s trading partners including Australia.”

“Yesterday, Lowe warned that “there are risks on the horizon, with the Chinese economy going through some difficult adjustments. One of these is the switch from a growth model based on industrial expansion to one based more on services. Another is managing an increasingly large and complex financial system. Australia has a strong interest in China successfully managing these challenges.”  From the RBA’s perspective, the challenges from China are likely to be better managed with a soft AUD.  Current levels of weak wage inflation should allow the RBA to be a laggard in term of G10 central bank policy tightened and we look for AUD/USD to trend towards 0.75 by the middle of next year.”