AUD GAINS LIMITED AS EURO ALSO RALLIES - 15TH JULI 2020 - Monex Europe

AUD GAINS LIMITED AS EURO ALSO
RALLIES
15TH JULI 2020

The Australian dollar has been one of the main beneficiaries of broad dollar weakness over the course of the

last month, as Australia's relative success in controlling the domestic outbreak led to lockdown measures

being scaled back earlier than in other developed markets.

This is evident in the currency market, with AUDUSD trading up to the 0.7 level in June " an 11-month high.

The Aussie dollar also rallied close to its 2020 high against the euro, with gains more contained against the

single currency as the euro also rallied from broad USD weakness. As a result, the AUD rally against the

EUR wasn't as dramatic as seen in AUDUSD.

AUD trading in the green vs USD over 1-month horizon

EURAUD over 6-month horizon

However, it doesn't look like plain sailing for the Aussie dollar anymore after a six-week lockdown was

announced on the 7th July, and fears of a second wave are increasing.

Cases currently exceed 10,000 while areas of Sydney have also been declared coronavirus outbreak

hotspots by the state government. On Tuesday, local authorities in Sydney announced that they would

reverse some easing of the social distancing measures " pubs are allowed to have a maximum of 300

patrons regardless of their size, and group bookings are halved to 10. Additionally, Victoria Chief Health

Officer Brett Sutton stated yesterday that further restrictions need to be considered as "we can't rule

anything out if there aren't sufficient mechanisms to drive down transmission". The surge in cases has

dashed the hopes of Prime Minister Scott Morison, who previously hoped he would be able to help revive a

crippled economy by easing most of the social distancing rules by end-July.

     Australia has so far attempted to absorb the economic blow of
     the virus using multiple fronts including fiscal, monetary and
     prudential tools.

The Reserve Bank of Australia reduced its cash rate target to the lower bound of 0.25% while expanding

daily market operations both in size and maturity to increase liquidity from the banking system. The central

bank also began explicitly targeting the yield on 3-year government debt, also set at 0.25%. Additionally,

the Bank implemented a funding facility to support non-bank lenders. At the fiscal level, the government

implemented a stimulus package worth A$137.2bn (7.2% of GDP) to support businesses and households

while also announcing A$5bn to strengthen the healthcare system. Reflecting these policy actions, the

recent economic data points to a somewhat better-than-expected quarter in June than initially feared,

although declines in GDP and labour have still been historically large globally.

Business confidence rebounded from -20 in May to +1 in June according to a NAB report released today,

while weekly consumer confidence had been sharply rebounding since the crash in March until a week ago

when stage three lockdown restrictions were re-imposed across Melbourne and Mitchell Shire. The Aussie

dollar reacted to the renewed virus fears and has marginally weakened against both the euro and dollar.

Looking ahead, the currency remains at the mercy of the dynamics of the local pandemic mainly as second

wave fears have become more advanced in Australia compared to other developed economies.

However, the currency's strength naturally remains tied to global risk appetite as well and the recent

localised outbreaks in Australia should be viewed in the context of the global outbreak.

In this light, it helps to explain why the Aussie dollar hasn't seen a substantial sell-off on the news of

Melbourne lockdown and Sydney's tightening of controls. The outbreak in end-Q1 and beginning of Q2 saw

a synchronised economic downturn globally with worse than expected economic data. However, the speed

in which the Australian authorities controlled the virus and therefore eased lockdown measures is evident in

currency markets with the AUD rally. Australia's economy is expected to have shrunk by 10% in H1 2020

according to the latest Reserve Bank of Australia monetary policy report, compared to 30% in the UK and

17% in the eurozone as per their central bank's forecasts. The Federal Reserve foresees a -6.5% change in

real GDP in 2020, which includes the anticipated Q3/Q4 bounce-back on the assumption that the economy

would be up and running in H2 2020. So while parts of Australia's economy have re-implemented stricter

lockdown measures, this must be considered against a backdrop of less initial economic damage. When

factoring in the current dynamics in the US as authorities battle to contain the outbreak in the sunbelt

states, and the difficulty other major developed nations are having with loosening lockdown measures, the

recent news about Melbourne and Sydney hasn't dramatically affected markets as much as it would have

back in Q1.

     In our last forecasts, we anticipated EURUSD to rally to 1.16 over
     the      next     four     quarters        and      AUDUSD          to     rally     to   0.76.
     Triangulation suggests EURAUD would fall to 1.53 in Q4 as we
     anticipate a stronger level of appreciation in the Aussie dollar
     for the reasons mentioned above.

This stems from Australia's success in handling the virus in the early stages, the RBA repeatedly suggesting

they won't cut into negative rates, and the central bank having no objections with the latest bout of

currency strength, unlike the Reserve Bank of New Zealand dollar. A prominent upside risk to this outlook

however is the implementation of the massive EU recovery package that will be discussed at the EU summit

on July 17-18. Should the recovery fund show signs of completion, the promise of further fiscal expenditure

for the economic bloc will likely result in a sharp appreciation in the EUR. Although, it must be noted that

previous discussions about the composition of the recovery fund have yet to bear fruit.

Forecast:

Author: Ima Sammani, Junior FX Market Analyst

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