Biggest Risk for the Australian Dollar this Week

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Over the last 2 months, the Australian dollar has been on a tear, rising from a low of 0.9582 to a high of 1.0580. Believe it or not – the interest rate cut from the Reserve Bank of Australia in early June marked the bottom for the Australian dollar. Lower interest rates are normally negative for a currency, but in the case of the Aussie, the RBA’s proactiveness helped to restore confidence and stabilize the Australian economy. The RBA is now gearing up for another monetary policy announcement but unlike the June meeting we do not expect the trend in the AUD/USD to be changed by this month’s outcome. The greatest risk for the Australian dollar this week won’t be the central bank meeting but instead, the heavy dose of Chinese economic data on the calendar.

In terms of data, this week is all about China and the currency that will be impacted the most by surprises in Chinese data will be the Australian dollar. As a major export economy that relies heavily on Chinese demand, Australia is particularly sensitive to the ebbs and tides of the Chinese economy. Earlier this year, fears of a hard landing in China weighed heavily on the AUD/USD but as the data began to support the notion of a soft versus hard landing, AUD/USD traders breathed a sigh of relief and took the currency higher.

All About China

This week, we will get a fresh look at how the Chinese economy has been performing with the release of consumer and producer prices, industrial production, retail sales and trade balance. Currently, the market is looking for slightly weaker numbers, which may be enough to threaten the rally in the AUD. Any major downside surprises could drive the AUD/USD back below 1.05 while any upside surprises could drive the pair to a fresh 4 month high above 1.06. There’s been growing speculation that the PBoC could loosen monetary policy further this year and next week’s economic reports will play a big role in that decision. With manufacturing and service sector activity slowing slightly in July, there’s a stronger chance of weaker data.

RBA Expected to Leave Rates Unchanged

Meanwhile the RBA is widely expected to leave interest rates unchanged for the second month in a row. Europe remains a global concern but the recent decline in Spanish and Italian bond yields reduces the level of tension in the market and the urgency for additional supportive action from central banks. Since the last monetary policy meeting, we have seen some signs of improvement in the housing market and consumer spending. Inflationary pressures are muted but the labor market remains weak with net job losses in July. Having cut interest rates in June, the RBA will most likely leave rates steady at 3.5% this week. We have heard very little from RBA officials outside of Governor Glenn Stevens calling Australia the “Lucky Country” which suggests that the central bank is comfortable with the current policy stance. As a result, steady rates will most likely be accompanied by neutral comments. At the end of the week, the RBA will also release its latest forecasts for the economy in their Quarterly Statement on Monetary Policy. Downward revision to growth estimates poses another risk for the AUD.

Australia’s AAA Status Should Still Help the AUD

However, even if Chinese economic data weakens, it may not reverse the uptrend in the AUD/USD because the strength of the currency has a lot to do with the relative stability of the Australian economy and its fiscal finances. Australia is one of the few AAA nations left with a meaningful yield. It has become an increasingly attractive safe haven for central banks looking to diversify their reserves. Recent data shows that the Swiss National Bank increased their Australian dollar exposures while officials in the People’s Bank of China recently met with Australian regional governments to discuss buying their bonds. We suspect that these are not the only central banks diversifying into the AUD. Last week’s European Central Bank meeting failed to provide any concrete solutions for Europe’s sovereign debt crisis. As long as the debt crisis continues to pose a risk for the euro, the Australian dollar will be an attractive safe haven for central banks and foreign investors around the world.

Kathy Lien
Managing Director

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