Aussie dollar hits a wall at 74 cents

Sean Callow

Westpac Bank

The US dollar is on track for its first weekly gain since June. The greenback has been undermined by America’s very patchy coronavirus control policies and political battles over fiscal support. This has placed extra pressure on monetary policy, with the Federal Reserve adopting a new policy framework that should mean that it keeps interest rates very low for even longer than previously thought.

This lack of yield support for the US dollar seems likely to weigh on it for some time. But short term, the US dollar has found support from a few different sources. One is relative growth prospects. The latest US data suggests less damage than expected from businesses having to shut their doors once again in response to the virus.

This week the Institute of Supply Management’s August manufacturing index reached a high since November 2018, while its services index remained firmly in expansionary territory. And while the US unemployment rate remains very high, weekly initial claims for jobless benefits were the lowest since March.

In contrast, after hitting a 2 year high against the dollar, the euro has been undermined by disappointing Eurozone data including German retail sales and very low inflation.

This softer European data and a strong euro has prompted several officials from the European Central Bank to express their concern over the currency. This will add to the focus on the ECB meeting next week, though of course its monetary policy is already very loose, including a negative 0.5% rate on deposits held at the ECB.

This week the Aussie dollar traded above 74 cents for the first time since August 2018. After its meeting on Tuesday, the RBA noted the Aussie’s rally but pointed out the strength of commodity prices as well as the US dollar’s broad-based decline.

However, while the RBA kept interest rates on hold at 0.25%, it expanded its facility which provides cheap funding to banks on the condition that they increase lending to businesses. The RBA also said it would “consider how further monetary measures could support the recovery.” So perhaps this will weigh on the Aussie in coming months.

Australia’s key economic data release was of course Q2 GDP. The 7% fall was close to expectations, as consumer spending slumped with a wide range of businesses closed due to the pandemic. The Australian economy is 6.3% smaller than a year ago, a much sharper fall than in previous recessions. However, it is not nearly as dramatic as in other nations such as the US, which is down about 9%, let alone the UK, which slumped around 22%.

But the question remains, what sort of recovery can we achieve? As noted earlier, the US economy seems to be bouncing back sharply in Q3. But given Victoria’s lockdown, the RBA expects Australia’s GDP to be about flat in Q3, with growth only resuming in Q4.

In the week ahead, we will see updates on Australian business and consumer confidence but the global mood is likely to be key. On the positive side, iron ore prices are up to $130 per tonne as Australia continues to record trade surpluses.

But equity markets are a wild card. The Aussie’s highs this week lined up with record highs for global equities. But the selloff later in the week knocked the Aussie down about 1 ½ cents to 0.7250. 

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Sean Callow
Senior Currency Strategist
Westpac Bank

Sean Callow is Westpac Bank's Senior Currency Strategist, based in Sydney. Sean focuses on the Australian dollar and other G10 and Asian currencies. He has worked in strategy and economics roles in New York, London, Singapore and Melbourne.

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