Keep the hope, face the reality on Australia

FX Focus: AUD

Keep the hope, face the reality!

A subdued outlook for exports, weakening terms of trade, and a relatively dovish RBA are headwinds for the AUD.We revise down our year-end forecast to 0.72, reflecting a more moderate upside despite improved risk sentiment.A broader recovery in China is an upside risk, while the RBA’s reaction function may turn into a tailwind later.Given the nearing conclusion of tightening cycles by major central banks, a positive shift in risk sentiment, reduced volatility, and the stabilization of global growth, it is reasonable to expect the AUD to outperform based on its past behaviour. However, there is a notable discrepancy among cyclical G10 currencies in the recent decline of the USD since March 9 (as shown in Chart 1). The weakening of the USD has primarily favoured currencies with stronger growth momentum, improved terms of trade, and more hawkish central banks. This explains the limited reaction of AUD-USD (as depicted in Charts 2-5).

The primary obstacle facing the AUD is the subdued forecast for China's demand for Australian exports. The oversupply in the steel market and the slow pace of property new starts in China adversely affect Australia's commodity exports. Additionally, the limited capacity for outbound flights from China hampers the recovery of Australia's services exports. Furthermore, negative seasonality in tourism poses a short-term challenge. Given the uncertain outlook for commodity demand and a cautious budget for 2023-24, investments related to fossil fuels offer limited potential for growth.

Furthermore, the AUD has struggled to benefit from global growth through the commodity channel. As elevated commodity prices have acted as a significant constraint on the growth of numerous economies, the stabilization of global growth and positive surprises have coincided with declining commodity prices and a deterioration in the AUD's terms of trade.

With the conclusion of major central banks' tightening cycles drawing near, I believe the balanced reaction function of the RBA could become a source of strength for the AUD. Market sentiment is likely to shift in favour of currencies whose central banks are anticipated to maintain low interest rates for an extended period, and in this aspect, the AUD is an ideal contender.

However, I have revised my year-end forecast downward to 0.72, considering a more demanding future for the AUD despite the improvement in risk sentiment and the normalization of market volatility (as shown in Table 1). Nevertheless, I remain optimistic that the AUD can still experience a modest recovery.

1. The performance of cyclical G10 currencies has started to diverge during the latest USD downtrend since 9 March

 Source: Bloomberg, HSBC

2. The USD’s weakness has mainly

 Source: Bloomberg, HSBC

3. …and improving terms of trade…

 Source: Bloomberg, HSBC

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