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Australian Dollar Outlook: Hawkish RBA Underpins AUD for Now

AUSTRALIAN DOLLAR FORECAST: BULLISH

  • The Australian Dollar is hostage to external factors for now
  • RBA rate hikes are coming chunkier and faster than anticipated
  • Commodity prices and China’s growth remain in the frame for AUD

The Australian Dollar closed the week not very far from where it started, but it has been on a wild ride en route, dipping to 0.6850 before recovering back above 70 cents.

A plethora of central bank rate hikes and fears of recessions has generated significant uncertainty and volatility has spiked as a result.

In this latest round of debt repricing, equities, bonds and currencies have seen volatility jump to elevated levels, but not so much in commodity markets.

The chart below shows the VIX and MOVE indices for stock and bonds respectively. EUR/USD and OVX (crude oil volatility index) are used as proxies for currencies and commodities.

VOLATILITY CHART

Australian Dollar Outlook: Hawkish RBA Underpins AUD for Now

Chart created in TradingView

This could indicate that the market is comfortable with commodity pricing for now. At the very least, raw materials are not seen as a financial asset impacted by the tightening cycle, yet.

The backdrop to such an appraisal is the Ukraine war and supply constraints that continue to plague the Chinese economy.

The outbreak of war unleashed turmoil on commodity markets and continues to do so in certain pockets of the energy complex. Overall, prices are relatively stable at levels above where they were before the war.

This has boosted Australia’s trade balance: around AUD 10 billion is added to the nation’s bottom line each month. Many commodities that Russia and Ukraine supply to the world, Australia does also.

In China, the continual pursuit of a zero-case Covid-19 policy means that further lockdowns are likely for the foreseeable future.

While recent easing of restrictions has given hope to the economic outlook there, of concern is that there doesn’t appear to be an exit plan for China from the pandemic.

While long term contracts are in place for the bulk commodities that Australia supply to China, perennially slow growth there may eventually undermine the volume sold.

Domestically, the current state of affairs remains as robust as ever for the Aussie, but there are clouds on the horizon. This week, RBA Governor Philip Lowe stated that Australians should prepare for a cash rate of 2.5% later this year in order to tame inflation.

With six meetings left for 2022, to get to that rate from the current cash rate of 0.85% implies at least one 50 basis point (bp) hike, if not more if the bank decides to front load the increases.

By any econometric modelling technique, AUD/USD remains undervalued. This highlights that the Aussie is caught in external circumstances, and it is the action coming out of the US in particular that is likely to drive the exchange rate.

After the Federal Reserve’s 75 bp hike last Wednesday, we can expect to hear from several Fed speakers in the coming week for guidance on their thoughts toward further lifts in rates.

— Written by Daniel McCarthy, Strategist for DailyFX.com

To contact Daniel, use the comments section below or @DanMcCathyFX on Twitter

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