Australian Dollar Macros Continue to Improve at the Start of 2018

Fundamental drivers of the Australian Dollar are improving at the start of 2018 amidst regulatory changes in China which have helped the outlook for metals and growth.

Analysts projections for the Australian Dollar in 2018 have been pretty gloomy.

They highlight high levels of personal debt in the country after years of ultra-low interest rates and RBA neutrality as two major reasons.

News out this week, however, may have them rethinking their positions.

Increasing environmental regulation in China saw metal prices continue to rally into the new year and this trend is expected to continue.

Most recently Copper gained a boost, rising from a low of 2.92 at the start of December to a high posted on Tuesday, January 2, of 3.30. This matters given Australia is massive miner and exporter of metals and the rise in the sector is sure to support the economy and demand for the currency.

"It seems increasingly likely that production cuts to protect the environment are going to be an ongoing feature of the metals market landscape. This will provide support for both mining stocks and the Aussie Dollar," says analyst Ric Spooner at CMC Markets. 

The effect on metal prices is likely to be an ongoing as China continues to ratchet up regulation to clean up its environment, suggesting a significant backdraught for the Australian Dollar both in the short, medium and potentially even long-term horizons.

The push to clean up the environment, which saw a raft of regulations introduced two years ago, has also affected the aluminium and iron ore industries in China.

In september Beijing revoked over a third of iron ore mining licences in an effort to crack down on miners who flaunted regulations and it has imposed substantial curbs on aluminium producers who do not meet stringent environmental laws.

The drive to clean up the environment and, in the words of Chinese Premier Li Keqiang, "make our skies blue again," is expected to lead to the closure of 30% of aluminium smelting capactiy between March and November every year, according to Alan Clark, Director of CM Group, a reasearch and advisory service in the sector. 

China's new preference for high grade iron ore is likely to favour South American and Australian miners who tend to produce the 60% plus ferrous content ore they like, as opposed to China's own low grade 30% ore.  

Growing Pains

Despite fears of deleveraging after the recent boom, China's Caixin Manufacturing gauge beat expectations hands down when the results were released on Tuesday morning, sending an invigorating boost into Asian markets at the start of the new year.

Whilst it's a little early to extrapolate, the data may have Aussie Dollar doubters starting to doubt themselves as visions of the perfect pairing of increased regulation strangling metals supply and continued Chinese economic growth provide Australia with the perfect opportunity, and the Aussie buck a buy on increased demand.

Too Negative on the Aussie Dollar?

Most analysts have been pretty downbeat about the prospects of the Australian Dollar in 2018.

Their argument is that Australians are burdened with too much debt after years of historically low-interest rates.

Now everyone is up to their eyeballs in debt and the proverbial 'party is over', with just the hangover - or the debt repayments - to come.

The strange combination of circumstances has left the Reserve Bank of Australia (RBA) with no-where to go.

It cannot raise interest rates because that would increase people's repayments and threaten a credit crunch, yet it cannot cut them either as this would encourage people to borrow even more.

Recently the RBA shifted minutely towards raising rates, saying the next move would probably be up, and this was a good sign for the Aussie Dollar as higher interest rates support a currency, but analysts have generally been sceptical about the RBA's determination to follow-through.

"The next move will be upward, but the RBA is not in a rush to do that and the strength of the AUD is also seen as slowing economic recovery and inflation," says Unicredit Economist Dr. Vasileios Gkionakis.

Gkionakis predicts a high chance of the RBA increasing interest rates from 1.5% to 1.75% in 2018.

"The Australian forward curve does not look mispriced by reflecting a 60% chance of one rate hike in the next 12 months and a 90% chance of two moves in the next 24 months," adds the analyst.

The rise in metals prices is just the sort of supply shock which can have major reverberations across the financial system.

Commodities have been low for too long now and are cyclically ready for an upturn.

These sorts of major turning points in markets are often caused by major regulatory shifts which affect price fundamentals.

If the Chinese economy continues to grow at a steady rate defying slowdown fears that would be a further impetus for the Aussie Dollar as it would provide a ready market for Australian exports.

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