Australian Dollar Falters with Soft PMIs and Carry Trade Impact | Weekly Update

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29 July 2024

Written by
Ebury

AUD

The sell-off in high yielding currencies continued to batter the Australian dollar last week, which underperformed almost all of its major peers as the carry trade unwind took hold. The July PMIs of business activity were also on the soft side, which have partly worsened concerns over the state of Australian economy. The composite index, which represents a weighted average of activity in both services and manufacturing, is now printing only just above the level of 50 that separates expansion from contraction (50.2), its lowest level since January.

Despite the modestation in domestic activity, markets are continuing to price in a non-negligible chance that the Reserve Bank of Australia hikes interest rates again at one of its next three policy meetings. Wednesday’s Q2 inflation report could be key in determining the direction of the next move in rates. We suspect that even a large upside surprise here would be insufficient to force the RBA to raise rates again, although it may delay the expected start date to cuts, which would be bullish for AUD.

NZD

There were very little macroeconomic or policy developments in New Zealand last week, with NZD driven almost entirely by the global unwinding in carry trades, and subsequent sell-off in high yielding currencies. The July Roy Morgan consumer confidence index did surprise to the upside (87.9), and increase to its highest level in five months, although this was largely overlooked by investors.

We continue to favour an underperformance in the New Zealand dollar relative to its Australian counterpart, as the RBA keeps rates on hold while the RBNZ engages in an aggressive easing cycle. Markets are pricing in slightly less than a 50% chance that the RBNZ lowers rates in August. We think that the bank will err on the side of caution, with a first cut in October appearing a safer bet.

USD

The Federal Reserve will be unveiling its latest policy decision on Wednesday, with FOMC members convening at a time when the US economy has shown signs of resiliency over the past two weeks, contradicting the narrative of a sharp slowdown. This includes last week’s impressive second quarter GDP report, which showed near 3% annualised expansion and an economy growing at double the pace from Q1.

Nevertheless, with inflation recent prints coming in squarely in line with the Fed’s target, the room is open for cuts starting in September, and we expect Chair Powell to implicitly confirm this at the press conference this week. This could open the way for a weaker dollar across the board, as rates are one of the factors that have kept the greenback so expensive over the last two years.

JPY

In line with our forecast, we’ve seen growing speculation that the Bank of Japan could hike interest rates at its policy meeting on Wednesday. We expect the BoJ to follow through with another 10 basis point hike, and suspect that officials will also unveil plans to lower its purchases of Japanese government bonds. This is not fully priced in (7 basis points) so we could see some strength in JPY off the back of the decision, albeit a dovish tone in the statement could limit the move.

The unwinding in carry trades continues to boost the yen, as markets bet on a narrowing in rate differentials between Japan and practically everywhere else. Any communications from the BoJ that indicate additional hikes are on the way could exacerbate these flows, and may send USD/JPY back below the 150 level.

CNY

Asia FX, led by the yen, has outperformed amid the unwinding of carry trades. The yuan was no exception, managing to recover some of its previous losses against the US dollar. On Thursday, the PBoC unexpectedly announced a 20bp rate reduction in the MLF rate to 2.3%. The unusually bold move followed cuts to other rates announced a few days earlier. Coordinated action to ease financing conditions adds to the sense that, despite constraints, due in part to the global situation, decision makers are wary of ignoring the economic reality.

Most of the economic news has indeed been disappointing of late, although last week’s acceleration in industrial profits in June provides a rare glimpse of hope for the sector. Looking ahead, attention will be on July PMI data, starting with NBS numbers on Wednesday. Headlines from the Politburo meeting, expected shortly, will also be closely watched, with markets hoping for additional support for the struggling economy.

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