Aussie dollar to weaken

Instreet Market & Economic Commentary

The Aussie dollar is likely to remain under pressure for the time being as commodity prices continue to fall and Australia’s interest rate premium narrows.

The price of Australia’s main commodity exports (namely iron ore and coal) have a strong influence on the value of the Australian dollar. Recently, iron ore prices have fallen to about US$65 a tonne – a big drop compared to the US$90 a tonne they reached late last year and earlier this year.

Even when pricing hit US$90, the Australian dollar didn’t get much above US$0.75. This doesn’t paint a strengthening outlook for the Australian Dollar in the current environment. 

As for interest rates, the rebound in underlying inflation in the first quarter of this year means the Reserve Bank of Australia (RBA) has little room to cut rates below the current record low of 1.5%. As such, Australia’s current interest rate premium is likely to be eroded as the US Federal Reserve (Fed) continues to hike rates in the US.

We expect the Fed will raise rates three more times this year which would take their policy rate above that in Australia for the first time since 2001. Another four Fed hikes in 2018 would leave it roughly 1 percentage point higher than the RBA rate.

US data

Any concerns you might have had about US employment growth back in March were alleviated this month following a 211,000 increase in non-farm payrolls for April. The data confirms that the 79,000 increase in March was just a weather-related blip. The official US unemployment rate is now at a decade low of 4.4%.

The report showed that wage inflation in the US is simply not a problem for the US economy even with what appears to be a tight labour market. Growth in average hourly earnings slowed to a year-on-year rate of 2.5% from 2.6% in the previous month; its weakest pace since August 2016. This slow wage growth will frustrate Fed policy makers as it’s not in line with what classic economic models would tell you.

Macron win to boost Europe

Emmanuel Macron’s victory in the French Presidential election may prompt a further rally in European equities and the Euro. The Euro may strengthen to around US$1.12, although we are not convinced it would stay strong for long. This, of course, would be good for European stocks.

The next point of contemplation for European markets will be June’s parliamentary elections in France. The markets do seem to like and sit and wait for the next event creating love levels of market volatility.  The low level of volatility in the market doesn’t mean that investors are being complacent. Indeed, we believe the market continues to climb a wall of worry based on the flows out of equities and into bonds and cash.

Likewise, low volatility does not imply that a sudden move is around the corner. Take the mid-1990s for example, when low volatility did not stop equity prices from rising steadily for years as the bubble inflated.

Oil in focus

Oil was a big talking point last week after Brent sank below $50 a barrel amid concerns about surging US output and skepticism over OPEC’s ability to keep a lid on global production. Increasing production out of Libya is contributing to the shale production growth story in the US. Overall, Brent finished down 5.1% for the week, having earlier fallen as low as 7%.

Falling commodity prices seemed to be linked to China’s economic performance rather than the focus on world growth. China’s local funding costs have been rising over recent weeks reducing the supply of capital to purchase stockpiles.

 

 

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