Australian Dollar to Remain Under Pressure on Domestic Factors

We expect the Australian Dollar to remain under downward pressure as domestic fundamentals rather than trade war issues will influence the currency into 2020. Recently, the AUD has risen in value driven by the most recent Federal Reserve interest rate cut, better sentiment towards U.S.-China trade negotiations and progress on Brexit. However, the currency has reversed recent gains as risk-off mood returned on trade as President Trump stated he won?t sign an agreement unless it?s the right one and further added that the U.S. could increase tariffs on Chinese imports if a broader agreement isn?t reached. Additionally, the UK entering a potentially divisive and damaging general election is also influencing the AUD. Data shows the AUD has the greatest sensitivity to Brexit-related news after GBP. This could mean the AUD will rise and fall over the course of the UK election period.

As mentioned earlier, the AUD will increasingly be influenced by domestic factors with the U.S.-China trade war relegated to a background factor. Furthermore, the ?internalisation? of China?s Yuan will result in the AUD becoming less of a China story and revert back to its influence in interest rate differentials which is currently at 1%.

Domestically, we expect the RBA to cut rates by a further 0.5% to 0.25% by mid-2020. Tax relief, the current small upturn in the housing market and increased public spending has not been enough to improve economic growth and inflation targets expected by the RBA. It would appear that consumers used the extra money to pay down debt rather than spending at the shops.

In addition, the unemployment rate, currently 5.3% is expected to increase to 5.5% next year and remain above the RBA?s estimate of full employment at 4.5%. We expect wage growth to remain subdued at 1.7% this year and 2.1% in 2020 and continue to stay below the RBA?s 3% level which is required to lift inflation to the 2%-to-3% target band. Excess slack in the labour market is the main reason hampering wage growth. Finally, we believe households are likely to save more next year as consumers will be reluctant to spend spare cash. This is evident in record low credit growth, 19-months of protracted downturn in new car sales, and building approvals at 6-year lows.

The AUDUSD has fallen 3% year-to-date and 7.4% since the end of June 2018. In the short-term, we see safe have assets rising in value with the U.S. Dollar and Yen benefiting at the expense of AUD thereby exposing it to short-term downside risk towards 0.6730. Within 12 months, we see the AUDUSD recovering to 0.69 on a gradual upturn in global growth but remaining subdued as interest rates in Australia are likely to remain lower in the long-term.

GBPAUD is at 2019 highs after the Australian economy lost 19,000 jobs and the unemployment rate increased to 5.3%. Although we expect the Pound to be volatile during the UK election period, we expect GBPAUD to go as high as 1.94 before settling down around 1.92.