Australian Dollar Rallies on Sharp Rebound in Chinese Economic Activity

- AUD bounces on Chinese data
- PMI bounces back from record low
- What's good for China is often good for Australia

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- GBP/AUD spot rate at time of writing: 1.9913
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A surprisingly strong rebound in Chinese economic activity in March has aided a recovery in the Australian Dollar, with markets betting that an early economic recovery in China will ultimately underpin Australia's export-orientated economy and lessen the extent of any recession.

Chinese Manufacturing PMI for March read at 52.0, which signals expansion, and is a result that comes in far above the 45 number markets were looking for. The PMI had plunged to a record low of 35.7 in February.

The Composite PMI read at 53, suggesting the country is well on its way to recovering the losses suffered during the coronavirus lockdowns of January and February.

"It does hold out hope for a relatively swift rebound in activity – a “V”-shaped recovery – once the virus is contained," says Marshall Gittler, Strategist at BD Swiss.

The Chinese economy is one built on manufacturing and it is the manufacturing sector that is the most likely to rebound in a v-shaped fashion following a lockdown. This is because production deferred in January, February and March can simply be made up in subsequent months.

However, an economy's service sector cannot simply make up for forgone business, for example consumers can't simply double their restuarant or cinema visits in the months following a lockdown and those businesses will suffer the effects from irretrievable business losses. Therefore, translating the recovery seen in China to more service-orientated western economies is not so simple.

"The release of the latest official PMI surveys added to broader evidence that activity in China has started to rebound," says Lee Hardman, Currency Analyst at MUFG. "It does not mean though that output is now back to its pre-COVID-19 trend rather that activity has improved."

Regardless, the numbers out of China are promising and do offer support for the Aussie Dollar, in the short-term at least.

China is by far Australia's largest trading partner and is the final destination for the majority of its foreign exchange earning exports, such as iron ore, coal and natural gas.

Should economic growth in China increase, demand for Australian exports will likely also increase, providing fundamental support for the country's currency. What's good for China often tends to be good for the Aussie Dollar.

Australian Dollar strength prompted a half percent decline in the Pound-to-Australian Dollar exchange rate to 1.9926, while the Australian-to-U.S. Dollar exchange rate rose a quarter of a percent to 0.6180.

Above: The Pound has been trending lower against the Australian Dollar over the past 24 hours

While the rebound in China's economic activity appears impressive, economists warn that an interpretation that the economy is once again firing on all cylinders would be incorrect.

"We expected a more modest bounce-back, but the details of the report largely were in line with our expectations. The output sub-index jumped to a near two-year high of 54.1, from 27.8, though that doesn’t necessarily mean that all is now well. February set a very low base—for all components—due to the extended Lunar New Year break and the then-widespread anti-Covid lockdowns," says Freya Beamish, Chief Asia Economist at Pantheon Macroeconomics Ltd.

Beamish does also provide a significant interpretation on what the data means for China's trade partners when she says the following:

"We’re seeing early signs that China’s post-lockdown revival won’t be enough to carry its trade partners out of their own holes, at least in the short run."

So while the data is supportive of the Aussie Dollar, that support might yet only prove to be temporary in nature.

The National Bureau of Statistics who released the PMI report also urged caution, noting "companies still face relatively big operational pressures” and that more firms are reporting funding shortages and falling demand than in February."

China's economic activity will likely increase over coming weeks thanks to ongoing fiscal and monetary support from authorities. Monday saw the People's Bank of China (PBoC) unexpectedly cut its seven day reverse repo rate from 2.40% to 2.20%.

The reverse repo is the interest rate the PBoC charges on loans to banks and cutting it is expected to aid the economy. Further support is meanwhile expected to be announced by the government over coming days.

"While the 20bp cut is the biggest cut since the PBoC, we expect the Chinese authorities to focus mainly on lifting government spending rather than loosening monetary policy. Over the weekend, Chinese state media suggested the government will increase its fiscal deficit, issue special sovereign debt, and allow local governments to sell more infrastructure bonds," says Joseph Capurso, foreign exchange strategist at Commonwealth Bank of Australia.

We wrote on Monday that we now saw four positives developments that signal the potential for strength ahead in the currency, telling readers the Aussie Dollar was likely to benefit from China likely being the first major economy to recover from the coronavirus.

Australian Dollar Sees Some Light Ahead

The Australian Dollar looks to end March on a more constructive tone amidst supportive news that includes a government support package for jobs, robust iron ore shipments, a declining rate of spread of the coronavirus in Australia and the already mentioned improved outlook for the Chinese economy.

Aiding the domestic picture was further support for the economy announced by the government on Monday that should ultimately lessen the downside impact of the coronavirus outbreak on the economy.

A $130BN jobs support package was announced which will see the government subsidise wages over the upcoming 6 months.

The main feature of the package is the wage subsidies of A$1500 every fortnight per employee to help businesses retain them. The total value of the government's support packages now stands at around $213BN.

Looking at exports, research from Westpac shows Australian iron ore exports were up 25% month-on-month by March 20 and up 26% year-on-year when grossed up for the full month, making it strongest March on record.

Adding Brazilian data, global iron ore traffic is up 28% year-on-year and March looks set to be the first combined 100mt month since December.

The data is remarkable considering the global economic slowdown linked to the coronavirus outbreak which has severely limited global trade flows and was expected to result in lower demand from China, Australia's main export destination for iron ore.

Iron ore is Australia's premier export and is therefore a significant source of foreign exchange earnings for the country and a critical component in keeping the value of the Australian Dollar supported, particularly as a slump in global investor sentiment denies the country of foreign capital inflows.

It was meanwhile reported over the weekend that half as many Australians are catching coronavirus as a week ago with the borders, pubs, and restaurants now shut.

Should Australia's infection rate have peaked then there is the real prospect that Australia is one of the least-impacted major economies. What will be important for global foreign exchange rates over coming weeks and months is the recovery rate of the world's economies, with those recovering fastest likely to see their currency benefit.

Australia is believed by economists to be experiencing its first recession in decades as a global economic slowdown combines with domestic efforts to halt the spread of the coronavirus outbreak which has ultimately shuttered the country's services sector.

Economists at ANZ, one of Australia's largest lenders, say they estimate that a six-week widespread shutdown in the second quarter, and then a progressive relaxation, will see GDP slump 13% over the quarter.

"Unemployment, unfortunately, will spike as a consequence, with more than a million jobs lost and the unemployment rate reaching 13%," says David Plank, Head of Australian Economics at ANZ Bank.

ANZ forecast the economy will rebound in the third quarter, but the after-effects of the downturn mean the recovery after this initial rebound is quite subdued.

By the end of 2021 unemployment is expected to be around 7%.

Any upgrades to the economic outlook resulting from an earlier-than-expected decline in coronavirus infections could therefore ultimately aid the Aussie Dollar.