Slowly but surely my base case that the US dollar weakness that has dominated markets for the past six months is over and a new upturn has begun is spreading into mainstream forex commentary. Obviously enough this means a weakening Australian dollar though how weak will hang on commodity prices as well. The latest fo turn is MUFG:
The US fiscal stimulus package of USD 1.9trn that takes overall fiscal spending to fight COVID in the US to around 25% of GDP remains the key catalyst for the strong growth outlook that lies ahead for the US. But the below chart highlights the more favourable economic conditions as of right now with the Apple Mobility data pointing to the US now back to normal on that measure. The average of the 3 mobility indicators (Driving; Transit; & Walking) on a 7-day average has returned to the 100-level, the starting base level of the data back in January 2020. The UK has also picked up relative to earlier this year while the situation in the euro-zone looks like it has just started to deteriorate again.
Americans come out to play
Unfortunately for Europe and the euro-zone, this very recent deterioration may have further to run. Looking at COVID infection rates across some key European countries, the 7-day average for Italy has turned clearly higher, in fact to the highest level since 2nd December. France too, with the 7-day average back to a level last seen in November. Germany’s turn around is tentative but could too be starting to turn higher. Across 7 key euro-zone countries COVID cases have jumped 20k since 3rd March to total 72k, a 38% increase. Italy yesterday announced tighter restrictions with 13 of Italy’s 21 provinces falling back into the ‘Red Zone’ level of tightest restrictions. France could also be about to tighten restrictions with hospitals reportedly overflowing as capacity hits limits.
To top this worsening picture off, we now have more countries across the euro-zone banning the use of the Astra Zeneca vaccine. With the cyclical divergence already becoming obvious, yesterday’s events will only reinforce the short-term economic divergence that’s coming which is set to further weight on EUR sentiment.
Europeans huddled at home
With markets yet to fully price the forthcoming second Biden stimulus package, pushing US yields and inflation higher as well, the thesis for a higher USD is now compelling. When we add that China will slow during H2 owing to its own credit tightening, and CNY rollover, a firming DXY case becomes strong.
The obvious asterisk is the FOMC which stops me from becoming outright AUD bearish. But I do not see it turning dovish yet. With catch-up growth underway and strong fiscal support, it can allow the obvious bubble in tech to deflate without macroeconomic consequences and being blamed for it. Higher yields are appropriate as growth rebounds as well.
At a certain point, like the end of 2015 or 2018, it may be forced to come in if the commodity or equity bubble deflation becomes destabilising, or the 30-year yield threatens US house prices. But we are not there yet for either.
In short, the base case now is that both commodity prices and the Australian dollar have already peaked for the recovery cycle.
