AUD/USD
Australia’s Q2 CPI inflation data is out on Wednesday. Consensus is for a 1.9% (QoQ) rise, and for the annual rate of inflation to lift to 6.2%, from 5.1% in Q1. Australia’s core (trimmed mean) CPI inflation is also expected to rise 1.5% (QoQ) to be 4.7%, up from 3.7% in Q1. The categories likely to lead the lift in inflation are housing, food, transport. Non-tradeables (domestic) inflation is likely to lift more than tradables inflation.
A higher-than-expected Q2 CPI inflation outcome would temporarily lift AUD/USD as markets increased their expectations that the RBA would have to lift interest rates higher than the current priced-peak of 3.65%. However, in the current economic environment, of a slowing global economy and a strong USD, any lift in AUD would only be temporary.
While Australia’s Q2 CPI inflation will be important in generating intra-day volatility in AUD, the major event for this week will be the FOMC meeting because that will have a major impact on the USD. Consensus is for another consecutive 75bpts lift in interest rates to 2.25% (upper-bound). The FOMC’s accompanying forward guidance will be a big factor in determining the USD’s intra-day reaction to the interest rate rise by the FOMC. However, with U.S. CPI inflation yet-to-officially peak from its current level of 9.1%, any dip in the USD is likely to be short lived.
It is possible that U.S. and global inflation peaked in June, it is too early to be sure. When the U.S. July CPI inflation data is released next month, we will have a better idea. Some of the indicators of a possible peak in U.S. inflation include the early signs of a slowing in the U.S. economy. Notably, U.S. weekly jobless claims
are trending higher, and various measures of inflation expectations have moved lower.
The narrative of a global economic slowdown will remain a headwind to AUD/USD, and continue to apply downward pressure on AUD/USD.
AUD/EUR
AUD/EUR continues to grind higher because of the economic challenges in the Eurozone. AUD/EUR will likely further rise until it becomes clearer just how much the global economy is slowing. If the slowing in the global economic slowing gathers momentum, then AUD/EUR will begin to decline, as AUD/USD depreciation accelerates. However, for now, AUD/EUR will continue to edge higher for two main reasons:
First, because the global economic slowing has not yet gathered sufficient momentum. Second, because Australia has had a structural change in its current account balance as a result of large amounts of mining investment
over the last 15-years. Australia’s current account balance has transitioned from a large current account deficit (averaging 4.5% of GDP for decades) to a large current account surplus, currently equal to 2.9% of GDP. While the Eurozone’s current account surplus has moved to a cyclical current account deficit because of the high cost of energy imports.
The Eurozone has now had three consecutive monthly current account deficits to May 2022. The upshot of these changes in both countries current account balances, are that AUD/EUR rises when there is a slowdown and challenges in the Eurozone economy. Whereas in the past, AUD/EUR used to fall when there was a slowing in the Eurozone economy because the Eurozone economy makes up such a large proportion of the global economy. Examples of declines in AUD/EUR during Eurozone slowdowns include the early 2020 pandemic, the 2010-2011 Eurozone crisis, and the 2008-09 global financial crisis.
It is notable that AUD/EUR closed higher last week, despite the ECB lifting interest rates (more than most of the market had expected) by 50bpts, to take the deposit rate from negative territory, to 0.0%. The current interest rate pricing suggests the ECB will also deliver another 50bpt increase in interest rates when the ECB next meet in September. High Eurozone inflation is guiding these ECB interest rate rises.
Similar to the pattern occurring some months after the RBA, RBNZ, BoE, BoC, and many other central banks lifted interest rates, EUR/USD is currently trading lower following the ECB’s rate rise. This is largely because of the dominance and outright demand for the USD, as well as because the U.S. Federal reserve is lifting interest rates more than most of the central banks.