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The Land Down Under
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Andrew Kositkun Foreign Exchange Head Trader
The Australian dollar (AUD) has made a remarkable recovery from its March pandemic lows. AUDUSD currently sits around 0.73 but is expected to weaken in 2021. For comparison, AUDUSD averaged 0.69 in 2019.
Analysis of currency drivers found that correlation with global equity markets overtook domestic factors as the dominant driver of AUD performance. To an extent, this was expected, as risk markets tend to have a high degree of covariance after a major business cycle event and especially with global policy rates near the lower bound and balance sheets actively expanding. As we move to and through 2021, risk asset trading ranges should be narrower, and the relationship between AUD and the stock market should fade. The resulting dynamic should give relative monetary policy an increased significance.
COVID-19 cases in Australia remain low relative to other countries and especially when compared with the U.S. and Europe. Virus seasonality suggests that virus outperformance should continue and lead to Australian GDP outperformance in early 2021 as Australia enters its summer months versus Northern Hemisphere countries as they enter their winter months. However, the degree to which the exchange rate benefits from this is not straightforward due to virus issues in the U.S. and Europe that should limit global growth and commodity price gains.
Additionally, domestic economic outperformance is unlikely to move policy rate differentials, as the Reserve Bank of Australia (RBA) has committed to catching up with other central banks, ensuring relative accommodation. This position can be seen through comments from RBA Governor Phillip Lowe in which he noted that without further balance sheet expansion, the gravitational pull of low global interest rates will generate unwanted upward pressure. Fortunately for the RBA, it holds a relatively low amount of government debt, allowing it to backstop its relative policy stance in 2021 and, if anything, catch up in terms of relative pace of asset purchases with other central banks that are closer to their limits.
On the trade front, Australia, along with China and other countries, recently signed the Regional Comprehensive Economic Partnership, the world’s largest trade deal. On the margin, this is a positive development, but recent times have demonstrated that trade agreements don’t eliminate trade tensions. As such, Australia’s trade profile will be dominated by the ongoing tensions with China stemming from the Australian government’s decision to support an investigation into the origins of COVID-19. Thus far, China has responded by placing sanctions on a number of Australian exports. These actions have been mostly symbolic with the exception of sanctions on coal exports. Notably, iron ore has not been targeted but could be if trade friction intensifies. Iron ore accounts for 25% of Australian exports. With 70% of these exports going to China, any sanctions will have a material impact.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
Fed Chair Jay Powell will address lawmakers later today and caution them on the state of the economy. In prepared remarks released yesterday, Powell acknowledges positives from vaccine progress for the medium term but noted significant near-term challenges, including timing, production, distribution and efficacy, and fading stimulus support.
News reports indicate that European leaders are drafting a plan to reset Europe’s alliance with the U.S. after tensions during the Trump administration. This plan includes opportunities for cooperation on everything from digital regulation to the pandemic and fighting deforestation. On the economic front, eurozone inflation numbers came in softer than expected.
Japanese Prime Minister Yoshihide Suga’s popularity has fallen for the second straight month as the Japanese economy struggles to recover and heads toward new lockdowns. Suga’s approval rating of 58% is a new low. How Suga’s approval ratings trend should play a key role in when the next election is called. An election needs to be held by 2021, and Suga’s falling numbers suggests elections, and additional fiscal stimulus, will happen sooner rather than later.
The RBA kept its cash rate and targets unchanged as widely expected. The bank did state that it is not expecting to increase interest rates for at least three years and that the bank stood ready to do more if needed.
Canada’s third-quarter GDP missed expectations but still rose 40.5% on an annualized basis. This historic gain is similar to the rebound seen in other advanced economies and reflects a low starting point and massive stimulus measures. However, attention has already turned to fourth-quarter growth, as it is expected to be flat or even turn negative.
China’s Caixin manufacturing PMI data came in stronger than expected at 54.9 versus consensus for a 53.5 print as the Chinese economy continues to recover.
The Organization for Economic Co-operation and Development lowered its forecast for 2021 global growth to 4.2% from 5%, as it sees recent outbreaks and lockdowns increasing risk of permanent damage. The downgrades were particularly acute in the euro area and the U.K., with growth in the latter cut to 4.2% from 7.6%.
OPEC+ delayed talks for two days as disagreements over production continue. A lot will depend on Saudi Arabia and Russia, but as of now, Vladimir Putin has no plans to speak to Saudi Arabia.
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