The global economy has been on its best roll in years and set to do even better in 2018, driven by a US economic expansion that is currently the third-longest since World War II. Despite this, the US dollar’s ride through 2017 has been mixed, its performance slumping from January to September, undermined by concerns regarding the Trump administration, a sustained run of weak economic data and an improving economic backdrop, namely in Europe and China. As we have moved through October and early November, it appears as though there has been a key shift in sentiment towards the greenback, climbing over 6% against the Aussie dollar. So what has caused this dynamic and is it set to continue?
On the political front, the contribution to the USD rally during October was developments that put US tax reform back on the table. With the US senate passing a budget resolution this now allows the Republicans to pass a tax reform bill. As I write this morning, the Republican tax plan had been released overnight, cutting the US corporate tax rate to 20% (from 35%) in addition to reducing 7 personal tax brackets to 4 and a lower tax rate for the repatriation of offshore profits. Whilst this did have a muted impact on USD direction, longer term this may prove inflationary for the USD and drive further gains.
Domestic politics also served to put a weight on the AUD late in the month as news that Deputy Prime Minister Barnaby Joyce had been ruled ineligible to stand for parliament by the High Court of Australia. Sitting in the House of Reps where the Coalition holds a majority by a sole seat, Joyce’s disqualification means that the government has temporarily lost its majority in the Lower House. With Prime Minister Turnbull adamant from the outset that his deputy would be cleared, both his and the government’s credibility has taken a further hit. This all played out on the last Friday of the month, following an action packed overnight session that saw the announcement of the aforementioned US budget resolution in addition to a European Central Bank (ECB) meeting that sent the EUR sharply lower and the USD higher.
On the back of these three events the Aussie dollar fell to its October lows at 0.7625, levels not seen since early July.
Earlier in the month the Aussie looked to be regaining its footing post a swift rejection of levels above 0.8000 US cents but ultimately failed at levels around the 0.7880 – 0.7900 region predominantly driven by the ever increasing positive outlook towards the USD. Local economic factors also played their part as another round of soft inflation numbers in addition to a Sydney-led national housing market slowdown reinforcing the view that the Reserve Bank of Australia will leave rates on hold for a sustained period. With US interest rates on the rise and the RBA on hold, monetary policy divergence will likely put restraints on the Aussie dollar retesting the 0.8000 US cent mark.
Throw in questions about the outlook for Australian households (weak consumer spending), underutilisation in the labour market and persistently low wages growth – there are a number of headwinds that the Aussie dollar currently faces. Many commentators, forecasters and strategists are now calling for levels in the mid to low 0.7000’s over the coming quarters.
Whilst the AUDUSD cross looks to be heading lower in the short to medium term, the outlook is less clear for AUDEUR.
Failing to break through key levels sitting just below 0.6700, it was a choppy month for the pair with the Aussie dollar ultimately ending the month circa 1% lower. The key event for the Euro came late in the month via the aforementioned ECB meeting with Mario Draghi fulfilling expectations for a reduction in the central bank’s stimulus program. On its own, announcing a reduction in the volume of monthly bond purchases would prove to be favourable for the Euro, however the end result for the Euro was the second largest post BREXIT sell off as Draghi also announced that the ECB would be in no hurry to raise interest rates, maintaining negative rates for the next 12 months. Having aggressively retreated to month lows, sub 0.6500, AUDEUR staged a swift recovery, climbing back through 0.6600. As the Euro recovery continues to play out and the ECB takes a closer step to normalising Euro zone rates, the Aussie dollar will likely head to lower levels retesting the low 0.6000’s seen in early 2016.