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If higher bond yields and recent spike in stock market volatility have you concerned the Australian dollar will continue to slide, don’t be, the Commonwealth Bank’s FX Strategy team says.
Not only does it think the recent weakness won’t last, it sees the Australian dollar rebounding strongly in the months ahead.
“While the relief rally in the US dollar (USD) may have more legs in the short term, we still expect a lower USD this year,” says Elias Haddad, Senior Currency Strategist at the Commonwealth Bank.
“[The chart below] shows the USD tends to underperform when global growth is improving. Stronger global growth will support commodity prices which bodes well for AUD, NZD and CAD.”
As it reveals, when the global economy is strengthening, it has often heralded weakness in the US dollar in trade-weighted terms — at least in the past.
Haddad says that despite recent tremors in stocks around the world, it’s unlikely to spill over into the broader economy, helping to underpin the commodity-linked Australian dollar as it has during previous economic upswings.
“The synchronised global economic upswing is intact underpinned by favourable monetary and fiscal policies,” he says.
“Leading economic indicators like the global manufacturing PMI remain consistent with world GDP growth of 3.6% and 3.4% in 2018 and 2019 respectively.”
Along with support from the global economy, Haddad is not convinced that the recent acceleration in US wage growth will lead the US Federal Reserve to lift interest rates aggressively given what are still weak inflationary pressures.
“We do not expect the Fed to shift to tight monetary policy settings and aggressively lift the target range for the funds rate — currently at 1.25-1.50% — above the neutral nominal policy rate of roughly 2.75% because of soft US inflation,” he says.
“The policy-relevant US core PCE deflator has been below the Fed’s 2% objective since May 2012.”
And even if US bond yields continue to scale fresh multi-year peaks, Haddad says this could actually act as a headwind for the US dollar in the months ahead.
“In the current low inflation environment, moves higher in US Treasury yields will to be self-limiting,” he says.
“Higher US ten-year Treasury yields can generate a deeper correction in US and global equities. This in turn will encourage the Fed to turn more cautious with its interest rate normalisation process and curtail upside for US Treasury yields.”
Combined with the view that the global economy will continue to strengthen, Haddad says the medium to longer-term risks for the Aussie remain to the upside.
“Our base case scenario remains for AUD/USD to trade closer to 0.8300 by year-end,” he says, noting that the “AUD/USD has important technical support between 0.7700 and 0.7750, its 200-day moving average.”
The AUD/USD currently sits at .7832.
