Australian Dollar Tipped for Losses Next Week by Bank Strategists

Image © Adobe Images

- AUD loses 2% in value.

- Commerzbank eye further AUD/USD declines.

- ANZ warn Fed decision could bite AUD next week.

- Aussie inflation figures also a threat on the AUD's radar next week.

The Australian Dollar fell close to two percent in the week ending Friday but could be set for further declines over the coming days, according to analysts at Commerzbank and Australia & New Zealand Banking Group (ANZ).

Australia's Dollar retreated this week after failing to overcome a key technical level last Friday, and as the greenback rebounded from earlier lows in response to data suggesting the U.S. economy is not quite as sickly as some in the market had come to believe. 

A brief period of respite from Brexit-related selling also enabled Pound Sterling to recover some of its recent losses, helping it to a one percent gain over the Aussie this week. Westpac tipped the exchange rate as a buy last week. 

Now, technical factors, the Federal Reserve (Fed) interest rate decision due next Wednesday and Australia's second-quarter inflation data are all risks on the radar of Australian Dollar traders. Commerzbank and ANZ are both wary that those events could augure yet more losses for the Aussie. 

"The US data pulse has been broadly positive since the June meeting and this obviously lifts the probability of Chair Powell taking a more cautious tone than the market is expecting," says Daniel Been, head of FX research at ANZ. 

Above: AUD/USD rate shown at 4-hour intervals, alongside GBP/AUD rate (blue line, left axis).

The Fed is widely expected to reduce its interest rate by 0.25% in July and again in September, before cutting once more in early 2020, which would leave the top end of the Fed Funds rate at just 1.75%. It's currently 2.5%.

Surveys have suggested the U.S. manufacturing sector struggled in recent months amid multiple trade disputes between the White House and other countries, stoking fears for the economy and prompting markets to speculate the Fed will cut interest rates before the slowdown gathers momentum. 

However, second quarter GDP data released Friday was stronger than the market anticipated. That data followed retail sales figures that suggested U.S. consumer spending picked up sharply in the recent quarter after a brief lull at the beginning of the year. The economy also gathered steam in the first quarter. 

Meanwhile, some in the market have continued to bet the Fed might announce a large 0.50% cut next Wednesday. The top end of the July 31 Fed Funds rate that was implied in the overnight-index-swap market on Friday was just 2.21%. That's below the 2.25% that would prevail following a standard 0.25% cut. 

"With the market still pricing in a chance of a 50bp move, we think there is scope for disappointment," Been writes, in a note to clients Friday. "Should this occur, the AUD is likely to feel the pinch of a firmer USD."

Above: Implied probabilities of 0.50% (left column) and 0.25% rate cuts. Source: CME FedWatch Tool.

Changes in interest rates are normally only made in response to movements in inflation, which is sensitive to growth, but impact currencies because of the push and pull influence they have over capital flows. Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

The Federal Reserve raised its interest rate four times in 2018 as the U.S. economy expanded at an increased pace, aided by White House tax cuts, and is only just beginning to contemplate cutting rates. But on the other hand, the Reserve Bank of Australia (RBA) has already cut its cash rate twice this year, taking it down to a fresh record low of 1.5%. And financial markets are betting it'll cut again before the year is out. 

ANZ says these interest rate changes and other fundamentals mean the 'fair value' for the AUD/USD rate is just 0.65, which suggests the Aussie currency is still 'overvalued' even after this week's decline. Australian inflation data due out next week will be important in this respect, because its consumer price pressures that the RBA is attempting to manipulate with its policy decisions.

"Our forecast is for headline inflation of 0.5% q/q, pushing the annual rate up to 1.4%. Core (trimmed mean) inflation is expected to rise 0.3% q/q," says ANZ's Been. "June retail sales will be an interesting test of some anecdotal evidence that consumers brought forward spending in anticipation of additional income from the tax cuts."

Above: AUD/USD rate shown at daily intervals, alongside GBP/AUD rate (blue line, left axis).

Any surprise fall in inflation could get markets betting the RBA will cut its cash rate again sooner rather than later, hurting the Aussie in the process. However, others are less concerned with damage next week's economic data and rate decision might do to the Aussie, and more so about recent trends and momentum signals on the charts.

"AUD/USD continues to ease back from a very tough band of resistance, namely .7065/87. This is the location of the 200 day moving-average [MA] and the 8 month downtrend. The market has reached its interim target, namely the 55 day ma at .6956, and this has been eroded. This targets the .6911 10th July low, which guards underlying support at .6865 the 17th May low and the mid June low at .6832," says Karen Jones at Commerzbank. 

Commerzbank's Jones, who studies trends and momentum on the charts, says there's a chance the current downward correction could take the AUD/USD rate all the way back to 0.6832. She's warned that a move below that threshold would open the door to a deeper descent toward 0.6738.

Jones told institutional clients this week they should sell the AUD/USD rate around 0.6980, which is the same as betting on a price fall, but walk away from the trade if the market rises back above 0.7020. The exchange rate hasn't been back across the 0.70 threshold since the recommendation was made.  

Time to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.

* Advertisement