AUD/USD
Last week AUD/USD closed at 0.6932, its lowest level at the end of a particular week, in almost two-years. The lower close on Friday, despite U.S. equities lifting on the day, suggests there is more near-term downside in AUD/USD this week. And a decline to the 13 May low of 0.6829 is the least path of resistance. One of the key drivers of a lower AUD/USD has been USD strength. The foreign exchange market is driving further appreciation in the USD, more than a week after the stronger than expected U.S. May inflation reading (8.6%) and large lift in the University of Michigan 5-10 inflation expectations survey (to 3.3%). Last week was a relatively volatile week for the USD. After strengthening in the early part of the week, the USD began to ease following the FOMC meeting. The Fed Chair delivered some confidence that the Fed can eventually get inflation down. But further selling in global equities markets gave the USD a lift into the end of the week, as participants began to get concerned about the outlook for global economic growth. The FOMC lifted interest rates 75bpts to take the Fed funds rate to 1.75% (upper-bound). Fed Chair Jay Powell indicated that it was the unusually high 0.3%pt lift in the University of Michigan’s 5-10 year inflation expectations survey to 3.3% that drove the FOMC’s decision to lift interest rates 75bpt rather than 50bpts. The high 8.6% May CPI inflation reading on June 10 also encouraged the FOMC to lift interest rates by the larger margin. Powell stressed that they want to see inflation expectations anchored at 2.0%. The FOMC released a new set of economic forecasts, revising up their 2022 inflation forecasts to 5.2% (previously 4.3%) but lowering their 2023 and 2024 inflation forecasts
to 2.6% and 2.2% respectively. The FOMC also lowered real GDP growth forecasts for 2022 through to 2024 (to 1.7%, 1.7%, and 1.9% respectively), and raised the unemployment rate forecasts over the same period too. Of concern, the FOMC’s U.S. unemployment rate forecasts were lifted to a median forecast of 4.1% in 2024. This is a large 0.5% forecast lift from the current U.S. unemployment rate of 3.6%. The concern is magnified when one considers that the U.S. economy has never avoided a recession when the U.S. unemployment rate has lifted more than 0.3%pts. The ramifications for the USD are very clear if the U.S. economy goes into a recession in 2023-2024 or earlier. The USD typically rises on a safe-haven bid if the U.S. economy goes into recession. That is because a U.S. recession typically induces a global recession, and most “other’ currencies fall during a global recession, generating upside support for the USD. With regards to last week’s Australian economic data, the May labour market report was very encouraging. The large 0.4% jump in the labour force participation rate (created by a high number of people joining the search for work), has meant Australia’s unemployment rate remained unchanged at 3.9% despite a large lift in total employment (+60.6k). If the participation rate had not lifted so much, the unemployment rate would have fallen to at least 3.8%, possibly lower. Next week, the Australian domestic economic data includes the minutes of the RBA’s June policy meeting (Tuesday), where the RBA lifted interest rates 50bpts to 0.85%. On Tuesday, the RBA will also release a review of the Yield Target Policy it employed during the pandemic emergency settings. The RBA Governor Phil Lowe will also deliver a speech on the “Economic Outlook and Monetary Policy”. Other important economic Australian data releases include the June Australian PMI Thursday). On Friday, Phil Lowe will appear on a panel discussion discussing “Central Banks and Inflation” in Zurich.
AUD/EUR
Last week AUD/EUR closed at 0.6609, its lowest weekly close since the end of February. A softer AUD/USD was largely behind the decline in AUD/EUR, with EUR/USD closing the week largely unchanged despite rising market concerns about “fragmentation risk” within the Eurozone. The fragmentation risk refers to the government bond yields of member Eurozone countries lifting significantly above the bond yield of the benchmark German government bond yield. This development generates a widening in the spreads between the different Eurozone country’s bond yields. As the market prepares for a lift in official Eurozone interest rates, concerns grow over the ability of the sovereign country whose bond yield is rising the most, to repay borrowed money. Fragmentation risk occurred during the 2010-2011 Eurozone economic crisis. It was eventually resolved with “political will” as the then ECB President Mario Draghi stated the Eurozone will do “whatever it takes” to fix the issue. However now the ECB is looking to bring in a specific tool to deal with fragmentation risk. This will probably involve large purchases of countries whose bond spreads are rising. The lower weekly close in AUD/EUR suggests that the market is starting to place a greater level of concern about slowing global economic growth, than simply slowing European economic growth. Therefore, the risk is growing that AUD/EUR declines to 0.6400 over the next few weeks, as the wider global growth concerns increase.