Yield spreads to chip away at AUD/USD but commodities more supportive – Westpac

AUD/USD has been trading mostly less than 1 cent from our short term fair value estimate in recent weeks, generally looking comfortable inside 0.75-0.77, suggests Sean Callow, Research Analyst at Westpac.

Key Quotes

“The apparent overvaluation of Aug-Sep has been removed, with the RBA appearing to agree, softening its language on the currency in the December statement to “The Australian dollar remains within the range that it has been in over the past two years.”   

“Domestic event risk into the new year is light as usual. While the details of Q3 GDP last week were concerning, business investment is on the rise and the RBA will also take heart from the renewed surge in job creation in November. Jobs growth above 3%yr will reinforce the RBA’s expectation/hope that wages growth will finally pick up.”

“As such, AUD should benefit from stability in short end rates, as markets ignore the notion of a rate cut and remain focused on the timing of the rate rise that the RBA says is most likely the next move. Soft inflation ensures a hike remains a near-zero chance in market pricing until May 2018 but pricing for H2 2018 should remain fluid in coming months.”

“AUD’s commodity price support has picked up a little lately, with Chinese steel prices squeezing higher, to the benefit of iron ore and coking coal. The volatility and seasonality in industrial commodities though suggests AUD won’t be able to count on recent prices being sustained far into the new year. Further out, we also have a somewhat sub-consensus view on Chinese growth.”

“Westpac’s baseline view is that yield spreads chip away at AUD/USD over 2018, with the 0.75 target for end-Q1 assuming that Fed tightening plans are not derailed early in the year à la Jan 2016. For AUD/USD to sustain rallies in coming weeks beyond say 0.7750, it is likely to require an unexpected slide in the US dollar. One catalyst would be the collapse of the US tax plan, but this risk could be removed as soon as next week.”

“There seems to be a stronger case for AUD/USD to trend lower into the early weeks of 2018. As Rich notes on p4, partial data for Q4 GDP look mostly promising, while Fed commentary should be quite upbeat, reinforcing their baseline view of 3 hikes in 2018, compared to current pricing of around 2 hikes. If the greenback does indeed start the year on a firmer note, AUD/USD should spend more time near 0.75 than testing 0.77.”