RBA: AUD pain point is here – Deutsche Bank

The recent strong appreciation of AUD has complicated the adjustment underway in the Australian economy, according to Tim Baker, Strategist at Deutsche Bank.

Key Quotes

“Since April 2016 the RBA has been relatively relaxed around the AUD, simply noting that “an appreciating exchange rate would complicate the adjustment underway” in the economy. The last couple of weeks seems to have brought that appreciation – the AUD TWI now sits 5% above the average of the past 18 months.”

“In 2014/15, RBA commentary tended to describe the AUD has above fair value and needing to fall. The AUD’s return to those levels might suggest a return of that language is coming also. But looking at the AUD in isolation makes little sense – changes in key currency drivers need to be considered. AUD has derived little support from interest rates. When the RBA was last concerned about the currency Australian 2-year yields were 100bps above the US – that’s since halved.”

“The iron ore price has been more of a driver – it’s recent 25% gain has coincided with AUD strength. But even on this measure the AUD looks to have run a little too hard. If we normalize the AUD and iron ore price, and take the difference, we can get a measure of how high/low the currency looks. When the AUD was last this high vs iron ore, the RBA was expressing concern.”

“This suggests scope for RBA commentary to change, perhaps as soon as the Governor’s speech on Wednesday. On the same day Australia’s quarterly inflation is released, with the market looking for underlying inflation to remain at 1¾% - below the 2-3% target range. The softness in the global inflation pulse, as reflected in inflation misses across most of G10, may present downside risk. And with inflation a lagging indicator, the softening in consumer spending a year ago also suggests downside. We retain our bearish view on the AUD.”