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Hawkish RBA supports the Australian dollar at the moment -by Ecork

Australian dollar forecast: Rise

  • The Australian dollar is currently hostage to external factors
  • The Reserve Bank of Australia’s rate hikes are coming bigger and faster than expected
  • Commodity prices and Chinese growth remain within the Australian dollar

The Australian dollar ended the week not too far from where it started, but it was on its way wild, dropping to 0.6850 before recovering back above 70 cents.

A large number of central bank rate hikes and recession fears have generated great uncertainty and volatility has increased as a result.

In this latest round of debt repricing, stocks, bonds and currencies have seen a jump in volatility to higher levels, but not so much in the commodity markets.

The chart below shows the VIX and MOVE indices for stocks and bonds, respectively. EUR/USD and OVX (Crude Oil Volatility Index) are used as proxies for currencies and commodities.

volatility chart

Schedule cread in TradingView

This may indicate that the market is comfortable pricing the commodities at the moment. At the very least, raw materials are not seen as a financial asset affected by the tightening cycle, yet.

The background to this assessment is the Ukraine war and the supply constraints that continue to plague the Chinese economy.

The outbreak of war caused turmoil in commodity markets and continues to occur in certain pockets of the energy complex. In general, prices are relatively stable at higher levels than they were before the war.

This has boosted Australia’s trade balance: about A$10 billion is added to the country’s net profit every month. Many goods that Russia and Ukraine supply to the world, as well as Australia.

In China, the continued pursuit of a zero-status policy for Covid-19 means that more lockdowns are possible for the foreseeable future.

While the recent easing of restrictions has given hope to the economic outlook there, the concern is that there does not appear to be an exit plan for China from the pandemic.

While long-term contracts are in place for bulk commodities that Australia supplies to China, the perpetually slow growth there could eventually undermine volume sold.

Domestically, the current situation remains as strong as ever for the Australian dollar, but there are clouds looming. Reserve Bank of Australia Governor Philip Lowe said this week that Australians should prepare for a 2.5% cash rate later this year in order to tame inflation.

With six meetings remaining until 2022, reaching this rate from the current cash rate of 0.85% would mean an increase of at least 50 basis points, if not more if the bank decides to pre-load the increases.

By any standard economic modeling technique, AUD/USD remains undervalued. This highlights that the Australian dollar is stuck in external conditions, and action from the US in particular is likely to be the driver of the exchange rate.

After the Fed raised 75 basis points last Wednesday, we can expect to hear several Fed speakers next week for guidance on their thoughts on further rate hikes.

— By Daniel McCarthy, Strategist for DailyFX.com

To connect with Daniel, use the comments section below or Tweet embed on Twitters

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