AUD/USD Flat, EUR/AUD Going Downward

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Includes: FXA
by: Citylytics

Summary

Australian economy is getting stronger.

The next RBA monetary step will be a rate hike in the second part of the next year.

The ECB will stick to its accommodative monetary policy far longer than the RBA.

EUR/AUD will see a downward correction through the course of next year.

At the beginning of the August I wrote an article "Why Is Shorting The AUD Vs. The USD A Good Idea?". As can be seen from the article, the AUD/USD traded at 0,7936 at that point. That being said, the AUD depreciated by roughly 4% against the USD since then.

Chart 1: AUD exchange rate

Source: Reuters

The latest RBA (Reserve bank of Australia) minutes are showing a rather optimistic outlook of the Australian economy. In detail, survey measures of business conditions and expected capital expenditure over the year ahead have increased. Also, forward-looking indicators of non-residential construction activity are pointing to further strength in the near term, and the pipeline of public infrastructure projects is remaining on high levels. September’s minutes also noted that dwelling investments are likely to stay at high levels in the next couple of years.

The board members observed that the labor market conditions have been surprisingly strong over 2017 and the leading indicators suggest that above-average employment growth will continue in the coming quarters. Also, the RBA board stated that the labor market adjustment to the downturn in mining investment was nearing completion. All in all, composition of growth is becoming increasingly broad-based while expected global growth strengthening is additionally underpinning Australian economy.

Chart 2: Components of the GDP (2Q17)

Source: Reuters

Chart 3: Unemployment rate movements

Source: Reuters

However, the RBA board described wages as weaker than expected and particularly low in the mining related parts of the economy. Indeed, the latest inflation print of 1.8% in October remains below the RBA’s target range of 2-3%. Despite the strong labor market the RBA Board expects only a slow build up of inflationary pressures, as wage growth remains subdued. In such circumstances the RBA Board is not very fond of AUD appreciation. In detail, the RBA board stated that any further appreciation of the exchange rate would lead to a slower-than-forecast pickup in inflation and economic activity.

Chart 4: Consumer price inflation movements

Source: Reuters

All in all, I believe that the RBA will want to avoid signaling monetary policy normalization until they see a sustainable upward inflationary pressures. The last thing they want is to intensify AUD strengthening. This implies that the RBA Board will stick to expansionary monetary policy for now.

However, the strong labor market will put pressure on inflation at some point as the economy is set to strengthen further. Therefore, I believe that the next monetary step will be a rate hike in the second part of the next year. The latter has two significant implications. First of all, I see the AUD/USD moving sideways for now as RBA’s verbal interventions and Fed’s rate hike in December will prevent AUD strengthening against the USD (caused by strongly improved macro outlook of Australian economy). Secondly, as the ECB will stick to its accommodative monetary policy far longer than the RBA (please see:"ECB: No Rate Hike On The Horizon"), I expect to see the EUR/AUD downward correction next year.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.