By Jim Iuorio, for CME Group
AT A GLANCE
- The Australian Dollar experienced more weakness and more volatility than its peers recently due in part to shifting demand in China
- Australian dollar futures saw record interest from traders in September
Is the recent data from China enough to stop the Aussie dollar’s 2-month slide?
From mid-July through September 5, the Australian dollar lost almost 8% against the U.S. dollar. Much of the move appeared to reflect a changing interest rate narrative in the U.S. that has bolstered the belief that the Federal Reserve can keep rates “higher for longer.” The main pillar of this analysis is that the recession that many were predicting several months ago may not be coming.
Although the stability of the economic data has pushed short-end U.S. rates modestly higher, it’s driven long-end rates much higher with the ten-year yield moving from 3.75% in early July to a 16-year high of 4.8% on October 3. When the move began in July, the difference between 2-year yields and 10-year yields was at a historic low of -108 basis points. That spread has quickly moved higher to a current level of -32 basis points.
The rhetoric coming from the Fed has changed along with the data as they adjusted their “dot plot” prediction of the Fed Funds rate in 2024 from 4.6% to 5.1% at their September 20 meeting. The simple takeaway is that the market believes the Fed and, more importantly, believes in the “soft landing” thesis which would allow rates to stay elevated.
The dollar has responded by rallying against all the currencies in the dollar index - a measure of the U.S. dollar against a basket of six foreign currencies – having left it with a higher week-over-week close for 11 straight weeks and a total percentage gain of around 7%. The Aussie dollar, however, has experienced more weakness and more volatility than its peers and the reason appears to be related to demand in China. Historically, the Aussie dollar has some well-defined correlations.
Australia exports a tremendous amount of commodities like gold, iron ore, and coal, so it would stand to reason that their currency would have a positive correlation with the demand and the corresponding price of those goods. And it does, usually. However, top on the list may be the economic health of their most important trading partner, China. Expectations for the Chinese economy were high when they eventually abandoned their “covid zero” policies, in late 2022, and allowed for the full opening of their economy. As the months have worn on, however, it has become apparent that the Chinese economy is not as easy to “turn back on” as the market expected and this seemed to have fueled Aussie dollar weakness through early September.
Around that first week of September, something changed that caused the Aussie dollar to have wild sideways fluctuations and extreme trading volume days. Aussie dollar futures at CME Group experienced the five highest all-time open interest days in their history from September 13 through 19. Open interest represents the number of outstanding futures contracts not yet settled. The biggest reason for this surge seems to be a modest rebound in economic data from China that suggests that their economy may have hit bottom and turned a corner.
First, data on Chinese factory orders and retail sales came in unexpectedly higher. This development seemed to cause a pause in the Aussie slide and pushed the currency up almost 2%. More recently, the purchasing managers index (PMI) came in above expectations at 50.2 versus expectations of 49.7. The generally accepted line in the sand for that data point is the 50 level, where it’s assumed that above that level indicates expansion and below it indicates contraction. Normal expectations would be for the apparent Chinese rebound, in a vacuum, to push the Aussie significantly higher.
Unfortunately, it didn’t happen in a vacuum. At the same time Chinese data was improving, three significant developments appeared to be a counterbalance to the Aussie’s strength:
- U.S. long-term interest rates accelerated their move higher as the market finally digested Fed intentions and the belief that more bond supply may be coming to market to finance government spending initiatives.
- Some high-profile union negotiations suggested that union wages may be adjusted significantly higher, fueling wage-price spiral concerns.
- The price of gold has cratered, breaking through some important technical levels that have it down over 7% from its late July high of 2,010. Of course, the move in gold is also related to the move in rates but there are some additional market position factors that may have accelerated the move.
On October 3, The Reserve Bank of Australia met and left rates at the current level of 4.1%. Futures market pricing in the Australian dollar remains near its lowest levels since just before the pandemic arrived in early 2020. That suggests market participants believe this may be a pause and that the hiking cycle may resume in coming months.
Several factors will weigh on the currency in the months ahead. However, for those interested in China’s fortunes, the AUD can at times serve as a gauge and bears watching.