This week we had confirmation that Australia’s economy contracted in the March quarter. This was enough for even the government to concede that the economy is in recession for the first time since 1991. A record fall in output is expected in Q2, as the -17.7% collapse in April retail sales effectively confirms. Consumer spending was already sluggish before the coronavirus shock, so recovery in the sector will be a long road.

Westpac expects the Australian economy by end-2021 to be smaller than end-2019, even after 4% growth next year. But in terms of setting expectations, Treasurer Frydenberg pointed out that Australia had avoided economic “Armageddon.” At this week’s Board meeting, the RBA appeared to be in a similar mood, noting that “it is possible that the depth of the downturn will be less than earlier expected.”

We’re not sure that this qualifies as a bullish story for the Aussie dollar but the currency nevertheless surged to nearly 70 cents this week, a 5 month high. We can point out some specific positives for the Aussie, including spot iron ore above US$100 a tonne helping Australia run a full year of current account surpluses for the first time since 1973.

Australia’s Covid-19 containment trend also remains encouraging. This raises hope that third quarter GDP might be positive. There are also a lot of Aussie dollars staying home instead of being spent overseas, with Australia’s overseas tourism spending down a stunning 99% in April versus 2019. The compulsory 2 week quarantine for all international arrivals is actually a positive for the currency.

But the main driver of Aussie dollar gains since March still appears to be the ongoing recovery in global risk appetite that has boosted equities and commodities for many weeks. Over the past month, the Aussie, the Kiwi and the oil-sensitive Norwegian krone have led G10 currencies, with havens Japanese yen, US dollar and Swiss franc the weakest.

The contrast is stark between such price action and appalling economic activity data, so risk-sensitive currencies are likely to be overshooting. Yet it is not obvious what will produce a major reversal near term. The market stresses of March now seem distant given the huge central bank response globally.

Major central bank support was emphasised again this week when the European Central Bank increased its pandemic emergency bond buying fund from EUR750 billion to EUR1.35 trillion, extending to June 2021. This flood of money not only helps keep European bond yields low but encourages some investors to switch to equity markets.

In the week ahead, we might also see further action from the US Federal Reserve, though policy settings are already very loose, so there could be more interest in new forecasts and commentary around the economy as coronavirus restrictions are loosened.

In Australia, the calendar includes June Westpac consumer sentiment and May NAB business confidence. These should reflect the gradual reopening of the Australian economy. But the Fed is likely to be the key to the global market mood and thus whether the Aussie dollar has another attempt at the 70 cent level. 

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