Australian Dollar Tipped to Stay on the Front-foot

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Foreign exchange strategists at Citi have said they retain a bullish approach to the Australian Dollar outlook, a view they say is further vindicated by strong Australian employment data out on Thursday.

The Australian Dollar outperformed its peers following a supportive mid-week U.S. Federal Reserve event that propelled investors to sell the U.S. Dollar and buy stocks, equities and commodity-linked currencies such as the Australian Dollar.

The supportive global backdrop for the Australian Dollar was meanwhile enhanced by a better-than-expected set of employment data that showed employment increased 88.7k in February, against the 30k the market was looking for.

The Australian Dollar outperformed most of its G10 peers with the Australian-U.S. Dollar exchange rate jumping 0.70% on Wednesday and a further 0.30% on Thursday to reach 0.7816.

The Pound-to-Australian Dollar exchange rate (GBP/AUD) fell a quarter of a percent on Wednesday and is a further 0.20% lower on Thursday at 1.7865.

Australian full-time employment meanwhile underpinned the overall growth in those employed as 29.5k jobs were added to permanent payrolls.

"We remain bullish AUD from a structural perspective and expect further appreciation following the dovish Fed overnight, which could asymmetrically boost commodity currencies," says Kurran Tailor, an analyst with Citi.

Australian employment is now back above its March 2020 level and near its pre‐Covid crisis level which leads markets to question how long the Reserve Bank of Australia (RBA) can continue with its cautious approach to monetary policy.

Foreign exchange analysts say that should the market start to bring forward expectations for when the RBA will raise interest rates, the Aussie Dollar will be supported.

However, the RBA will be loathe to withdraw support to the economy too soon and risk having Australian bond yields rise and potentially choke off economic growth.

The RBA will therefore likely point to the key underemployment rate as remaining elevated and consistent with considerable 'slack' in the economy.

Economic slack refers to the ability of an economy to add more jobs without risking pushing up inflation.

The RBA will therefore want to see the employment situation improve markedly over coming months before they stop pushing back against higher bond yields and the stronger Australian Dollar they would likely stoke.

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The gains in the Australian Dollar over the past two days mark something of a comeback for the currency which had declined into this week owing to softer iron ore prices on global markets.

The Australian Dollar fell amidst fresh headwinds besetting the iron ore market, a headwind that could grow stronger say a number of commodity analysts we follow.

Iron ore remains the single most important commodity in determining Australian Dollar valuation given Australia's heavy reliance on the raw material as a foreign currency earner.

Chinese iron ore futures have declined after top Chinese steelmaking city Tangshan pledged to cut emissions by 50% during the heavy pollution period and punish those who fail to implement production curbs.

Lower iron ore prices suggest Australia's earnings potential on the commodity will be lower, which is in turn reflected via a weaker Aussie Dollar.

"Iron ore prices have faced a correction this week after the Chinese steel-producing city of Tangshan imposed restrictions on steel production to reduce polluting emissions. With Chinese demand having been the key driver of higher iron ore prices over the past year, concerns about any slowdown in this sense should continue to have a magnified effect on iron ore prices," says Francesco Pesole, FX Strategist at ING.

Looking ahead, ING warn that a more sustained correction lower in iron ore prices is possible.

"We continue to deem the current levels of iron ore prices as unsustainable, and the material risk of a bigger correction is a major threat to AUD short-term ability to remain supported," says Pesole.

The supportive domestic developments in Australia's labour market will certainly depend a great deal on Australia's export prowess, therefore any deterioration in these exports could start to act as a headwind on jobs.

This is something that the RBA will be conscious of and could limit Aussie Dollar upside in the near future.