ANZ Research has released a note today arguing that the Australian dollar, which has rebounded strongly over the past few weeks, is likely to retrace as market expectations around China face a reality check:
While the Fed is the focus of the moment, we shouldn’t neglect China. The bounce in China growth expectations over recent months has been a key driver of the stabilisation in Asian currencies, and rally in the AUD and NZD, that had occurred in September even prior to last week’s Fed surprise (Figure 1).
Certainly markets have become more optimistic on China over the past two months as the data have stabilised. Our economists, however, expect China’s official growth target to shift from 7.5% this year to 7.0% next, and they forecast growth slowing from 7.6% this year to 7.2% next. A few indicators suggest we are close to the peak in the market’s expectations of China growth.
Consider that data surprises rose strongly from June/July. Now, however, they have reached levels which are typically consistent with a broader peak (Figure 2). In an environment where longer-term indicators continue to signal an ongoing downshift in growth momentum (Figure 3), data surprises should soon start to show some disappointment.
The China flash PMI is out later today, with the full suite of PMIs out the week after.
The market, and ANZ’s economists, is expecting another rise today, to take the index to its highest level since March.
The signal of a peak in momentum is also mirrored in the recent signs of weakness in some of the China-focussed commodity prices; such as iron ore and steel rebar (Figure 4). These prices based in June, around the same time as data surprises.
Both commodity prices have now retraced more than a third of those gains.
A unique measure of China-related commodity prices is the ANZ China Commodity Index (the CCI, Figure 5). This index weights commodity prices by Chinese consumption, rather than the global production weights used by most conventional commodity indices. The CCI fell 1.2% the prior week, and also likely fell modesty last week (some price reads are not available on the Thursday and Friday China holidays). It now looks to have peaked on 28 August.
Asian and antipodean currencies have received support for some weeks by an upshift in China growth expectations. Our medium term view is for growth in China to ultimately take another step down. While there are some uncertainties about exactly when this might occur, there are a number of partial indicators which suggest that expectations now risk being surprised on the downside…
Due to timing uncertainties over both the China view and the influence of the Fed, we position for AUD/JPY downside via an option (AUD/JPY put, 90 strike, for 143 yen pips). For the AUD, in particular, the short squeeze in positioning has likely run its course.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
