AUD/USD
AUD/USD declined more than 2.6% over the last week, hitting a low of 0.7055, before recovering somewhat. The main reason for the decline in AUD has been the relentless strength in the USD, as the interest rate market prices higher U.S. interest rates. Friday’s selling in AUD/USD was related to end-of-month selling associated with the adjustments in currency hedges because of the decline in global equities during the month of April. For more details, please see the AUD/EUR section. AUD/USD has now retraced all of its lift since the commencement of the 24 February Ukraine conflict. Looking ahead, this week’s RBA meeting will dominate direction in AUD/USD (see below). However, movements in AUD/USD will not be immune from the usual range of offshore influences. Those offshore influences, this week, refer mainly the outcome of the Fed meeting on Thursday. The FOMC is expected to lift interest rates 0.5% to 1.0% (upper-bound) and express a clear intent that they will lift interest rates again in the future. What the FOMC say in their accompanying statement will drive near-term USD direction, and hence, AUD/USD. The risk is the FOMC’s statement expresses an intent to lift interest rates in the near-term by larger amounts, generating another surge higher in the USD. The RBA meeting on Tuesday 3rd May will be one the of the most interesting RBA meetings in a while. The Australian Q1 CPI inflation report was significantly stronger than expected. Annual headline CPI inflation rose from 3.5% to 5.1%. This brings inflation to its highest level since the
1990s if one excludes the 2000-01 government-induced spike in inflation caused by the introduction of the 10% GST. Australia’s inflation is not just in a few areas. It is broad based. The favoured annual core inflation measure of trimmed mean, rose from 2.6% to 3.7%, its highest level since 2009. The RBA is facing a dilemma of its own making. A month before the release of stronger-than-expected CPI inflation data, the RBA stated it was waiting for both inflation and wages data before deciding upon interest rates. However, with much stronger than expected inflation data, even low wages data due on May 18 would not be enough to stop the RBA from raising interest rates. So the question is why wait? The other potential complication is there is an Australian Federal election on May 21, and the RBA does not want to be perceived to be meddling in the politics. So, this provides the RBA with another “excuse” not to raise interest rates on 3 May, and instead wait until June 7. However, the RBA is independent. And in 2007 the RBA raised interest rates just weeks before a Federal election. The RBA governor at the time (Glenn Stevens) made the comment, that “just because there is an election, it doesn’t mean I shouldn’t do my job.” Based on the RBA’s current cash rate target of 0.10% (and not the RBA’s overnight rate of 0.06%, which is affected by the large amount of exchange settlement balances that commercial banks hold at the RBA) we assess the interest rate market’s pricing. The OIS pricing for the May 3 RBA meeting is 0.262%. This implies a 101.9% chance of a 15bp interest rate rise, to bring the cash rate to 0.25%. The logic behind this pricing is the RBA can begin raising interest rates from the pandemic emergency low interest rate of 0.10%, and get the cash rate target back to 0.25% as quickly as possible. From there, the
RBA can then move interest rates in nice round 0.25% or 0.50% increments, as it typically has done in the past. An alternative scenario is the RBA lifts the cash rate target by 0.40% on May 3 to bring the cash rate to 0.50% quickly. The current interest rate pricing is suggesting there is a 65% chance of this occurring. The interest rate pricing for the RBA’s June 7 meeting is a cash rate of 0.64%, implying a 128% chance that the RBA lifts the cash rate to 0.50% by June 7. An alternative way of looking at the pricing for the June 7 meeting is there is an 85% chance the RBA lifts the cash rate target to 0.75% by June 7. Other interesting economic data out this week include the Melbourne Institute measure of inflationary expectations (Monday) which is likely to confirm Australia’s inflation challenge, and Australian retail sales and volume data for the March quarter (Thursday). The March international trade data, where another large $7.8 billion trade surplus is expected (is due Friday).
AUD/EUR
AUD/EUR remains more than 5% above the level it was trading at pre the Ukraine invasion. AUD/EUR did however, close the week lower last week of 0.6697. It is likely some month-end selling in AUD occurred on Friday, related to the decline in global equities during the month of April. The 8.8% decline in the benchmark equity MSCI world index over the month of April, typically results in end-of-month selling in AUD by institutions as they adjust their currency hedges to account for the lower value of the offshore asset (equities) that they are currency hedging. The ramifications of USD strength on the global currency market are clear. Generally speaking, EUR/USD is coming under more downward pressure than AUD/USD, leading to some support for AUD/EUR; this will continue to be the case while oil prices are elevated, and Europe’s economy continues to feel the pressure from the conflict in Ukraine. Last week’s data showed the Eurozone’s economy rose a modest 0.2% (QoQ) to be 5.0% (YoY). The details show Germany’s economy also rose a modest 0.2% (QoQ). France’s economy recorded zero growth in the March quarter. A contraction in the domestic economy was met with some contribution from inventories and net exports. Spain’s economy grew 0.3% (QoQ), half as much as expected. It is clear the Eurozone domestic economy is feeling the slowdown in quarterly GDP growth, which will continue to keep EUR heavy, and AUD/EUR supported. Particularly while the USD continues to strengthen. This week in the Eurozone, the economic confidence numbers for April are released. Softer numbers are the consensus for all confidence measures (economic, industrial, and services). The RBA is also likely to begin its tightening cycle. Please see the AUD/USD section above.