AUD/USD
Last week, AUD/USD closed at 0.7515, and near the high of the week. AUD continues to outperform, with the RBA’s trade-weighted index up 7.5% since the start of February.
The RBA will likely be viewing the AUD’s appreciation as helpful to dampen imported inflation pressures. The RBA will not be concerned that AUD’s appreciation will slow export growth, because exports are currently at a record high. Firmer energy prices (Australia is a net energy exporter), high commodity prices, a well-performing local economy, and a geographical distance from the Ukraine-Russia conflict are all assisting AUD out-performance.
Also helping drive some AUD appreciation is Australia’s record trade surplus and growing current account surplus, (3.5% of GDP) via longer-term valuation effects.
Australia’s real 10-year yield (adjusted using core CPI inflation) turned positive (currently 0.18%) for the first time since reaching its low of -0.935 on 31 Dec 2021. We make the observation that the RBA has never lifted the cash rate while Australia’s real 10-year yield has been negative, and so any further climb into positive territory by Australia’s real 10-year yield will likely lift pricing for near-term RBA cash rate increases (on the basis that the long-end of the curve leads the short-end of the curve), and further support AUD/USD.
RBA Governor Phil Lowe has commented about the importance of real interest rates recently when discussing the outlook for interest rates.
AUD/USD will likely continue to be influenced more by offshore developments over the next week given the lack of major domestic economic data due to be released over the coming week.
The two Australian domestic weekly economic highlights are the release of the 2022-23 Australian Federal Budget (Tuesday) and Australian February retail sales activity (Friday).
These days it is rare for AUD to have much of a reaction to the Australian Federal Budget because so much of the government’s policies and thinking are released by the press well-before the budget.
The major differentiator (risk) in the current environment could be some announced austerity measures by the government to try and reign in the large (albeit narrowing) budget deficit, and debt-to-GDP ratio build up.
However, we rate this as a low possibility because if one looks at Australia’s net debt, it is relatively low at around 32% of GDP. Nevertheless, if these austerity measures do eventuate, it may adjust RBA pricing a little lower, and temporarily dampen AUD.
It is more likely the budget will be “an election budget”. So more stimulus may well be announced, which would lift near-term RBA pricing for rate rises, and further support AUD.
What we do know is the Australian economy has been stronger than the government had forecast in the December (MYEFO), so there will be some downward revision to the next two-years budget deficit estimates. The starting point for the underlying cash 2022-23 budget deficit is likely to come in around 2.9% of GDP (A$70bn).
AUD/EUR
AUD/EUR looks set to further rise and test the 7 March high of 0.6866 driven by AUD strength and a bit of inertia in EUR/USD. The euro appears to be treading water while waiting for a clear direction in the next phase of the Ukraine-Russian conflict. Technically, a fresh weekly close above 0.6866 would open the door for AUD/EUR to rise and test of the 20 July 2017 high of 0.6932. Considering AUD strength has been the main driver of the recent lift in AUD/EUR over the last couple of weeks, it’s worth looking ahead to see what may move AUD/USD over the next week to get a gauge as to whether this may result in further appreciation in AUD/EUR. With this in mind, please see the AUD/USD section above. As far as non-Ukraine issues driving EUR are concerned, Friday’s preliminary estimate of the Eurozone March CPI inflation number, may generate some modest EUR strength if CPI inflation comes in above the expected lift in inflation from 5.8% to 6.3%. Such an outcome would temporarily drive Eurozone bond 10-year yields higher. However, the upside in Eurozone 10-year yields would appear limited while the conflict in the Ukraine continues because some market participants are asking whether a future Eurozone recession will occur as the impact of high energy prices continues to hamper the Eurozone’s economy. Australian ten-year yields on the other hand, continue to rise in response to the more favourable tail winds across Australia’s economy. The current level of both the nominal (and real) Australia-Eurozone 10-year bond spread suggests the direction of risk is for AUD/EUR to go higher.