AUD/USD
Last week, AUD/USD came under some downward pressure for three major reasons. First, the USD further increased on expectations the Fed will raise interest rates by another 75bpt at their next meeting to take the Fed funds rate to 3.25% (upper-bound).
Second, China extended lockdowns to a broader section of the community, generating fears of a slowdown in global demand, which put immediate downward pressure on the oil price and AUD.
Third, RBA Governor Phil Lowe delivered a speech saying that “the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises.” This helped generate a 17bpts decline in the Australian 3-year bond yield to 3.03%, and downward pressure on AUD. The implications are, after four consecutive 50bpts rate rises, the RBA may move to raising interest rate by 25 basis point increments over the remaining three RBA meetings this year. If so, this would take the cash rate to 3.1% by year-end.
The downward pressure on AUD/USD reversed on Friday, following the ECB’s decision to lift interest rates 75bpts, to take the benchmark ECB policy deposit rate to 0.75%. The ECB also provided the forward guidance that over “the next several meetings the Governing Council expects to raise interest rates further.”
This larger interest rate increase by the ECB, along with a policy change to temporarily allow interest to be paid on government deposits held at the ECB (see below) generated some EUR buying and USD selling. The USD selling helped lift AUD/USD into the end of the week, with AUD/USD managing to close the week higher at 0.6841.
This week, we have the Australian August labour market data. No change to the 3.4% unemployment rate is expected. Another good labour market report should generate some support for AUD. A firm labour market report would be consistent with last week’s economic data that showed the Australian economy (real GDP) grew a respectable 0.9% (QoQ) to be 3.6% (YoY) in Q2.
Looking ahead, the USD direction and the extent of the slowdown in global economic activity will be the main factors driving AUD. This week, the U.S. August CPI should show an easing in annual U.S. inflation from 8.5% to 8.1%, with an accompanying decline in U.S. inflation expectations, as surveyed by the University of Michigan. It is possible U.S. inflation peaked in June at 9.1% (YoY).
AUD/EUR
AUD/EUR remained under downward pressure over the course of last week, before regaining some lost ground on Friday, to close the week at 0.6812. Both the RBA and the ECB lifted interest rates by 50bpts and 75bpts respectively.
However, over the course of the week, RBA Governor Phil Lowe suggested that “the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises.” While the ECB provided almost the opposite guidance, stating that it “expects to raise interest rates further”,
implying large rate rises. The overnight index (OIS) interest rate market pricing is indicating a 60bpts rate rise at the next 27 October ECB meeting, and another 51bpts priced for the 15 December ECB meeting. Pricing for the ECB’s deposit rate is now as high as 2.50% by mid-2023.
EUR/USD is also likely to undergo some temporary appreciation courtesy of some FX portfolio reshuffling by major central bank FX reserve managers. This is because the ECB have made a policy decision to allow government deposits held at the ECB to (temporarily) earn interest until 30 April 2023. In the past, government deposits at the ECB had a “remuneration ceiling of 0% regardless of the ECB’s deposit rate.”
The ECB have decided to temporarily remove the 0.0% interest rate ceiling for renumeration of government deposits, to “prevent an abrupt outflow of (EUR) deposits into the market at a time when some segments of the euro area repo markets are showing signs of collateral scarcity, and will allow for an in-depth assessment of how money markets are adjusting to the return to positive interest rates.”
The importance of this policy change by the ECB change should not be under-estimated because global central bank (ie. government deposits of) FX reserves total US$12.5 trillion (or US$11.7 trillion in “allocated reserves”). Of which, EUR is currently known to be around US$2.3 trillion (19.6%), and the USD around US$6.9 trillion (58.9%) as at Q1 2022.
The ramifications are that the temporary buying of EUR, could generate some headwinds to AUD/EUR upside.