Weak Europe to crush Australian dollar rally

See the latest Australian dollar analysis here:

Is the Australian dollar an America, Europe or China proxy?

For a few months now I have been making the point that the Australian dollar rally is on unusually thin ice for this stage of the business cycle. Normally, with a  global recovery and a weak US dollar on the back of an easy Fed, we could expect to see the AUD rally for some time.  However, this cycle is different thanks to a number of factors.

The first is that the US has a lot more fiscal stimulus than it would normally and, more to the point, a lot more than Europe has or will have. This growth leadership is augmented by the US being well ahead on the vaccine rollout.

The second is that Europe is headed for a lot less inflation than the US, in part owing to a EUR that already rose too far, and in part the weaker recovery. Via Goldman:

Euro area inflation increased sharply in January, largely on the back of technical factors. Using conservative assumptions, in particular around the impact of the reversal of the German VAT cut, we find that one-off and technical factors account for over 1pp of the 1.2pp increase in headline inflation in January.

Using our Phillips curve framework, we find that underlying inflation pressures are still weak as inflation expectations are subdued and a large amount of slack remains in the economy. We look for sequential inflation to increase from the second half of the year as the economic recovery takes hold but expect only a gradual increase in underlying core inflation to 1.5% in 2024.

Just as European core inflation struggles, US core inflation is going to jump, headline even more:

The global bond back-up is going bifurcate into respective regions and the US will develop a yield advantage to go along with its stronger growth and inflation.

This is going to end the weak US Dollar Index (DXY) which will, in turn, end the Australian dollar rally as it tracks the EUR lower:

Once China begins to slow and commosity prices join the rout in H2 and 2022, the AUD will get a belting:

 

David Llewellyn-Smith
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Comments

  1. MathiasMEMBER

    Thanks David. Couldnt be clearer.

    So we should expect Reversals on the horizon for most major currency pairs. So the US Rocket ship is about to take off and force the rest of the world to inherit US deflation or print against the US currency. World Currency Markets to flip on there head.

    Bonds to the moon. Commodities crushed.

    Democrats rushing to send the bill to Biden’s desk by March 14, when jobless benefits are set to expire. So Im guessing we have till then.

    ” The House of Representatives passed President Joe Biden’s $1.9 trillion stimulus package ”
    ” Now, the bill moves to the United States Senate, where I hope it will receive quick action. ”
    https://www.cnbc.com/2021/02/27/stimulus-update-house-passes-bidens-1point9-trillion-covid-bill-heres-whats-next.html

    So Im guessing AUD to rise to .80 cents at least for the next month. March 14th, reversals hit, we got supports at levels of .68 , .63 , .60 , .55 . Trumps $800 bill didnt do that much in December. Granted, Bidens dumping twice that size but still. I mean, it would take a big hit but after March 14th, AUDUSD to fall to .68 cents?

    So Chinas the double whammy on commodities.

    So if Commodities ( Gold/Silver/Platinum ) are about to be smashed, then I guess parking your money in USD for a few years ( not leveraged to Forex ) while all this hysteria blows over, could see earnings grow while not putting your money at any considerable risk. Flipping it back into Commodities again when the situation becomes unfavourable.

    All very frustrating stuff. Whatever happened to a simple life.

  2. at this stage I will be still fading any USD strength, unless there is a war or something else that changes the overall trend. Political/debt:gdp and policy response is going to trump USD for me. Sure, short term USD strength very possible who knows maybe a good correction, but I will be looking forward to getting short USD again because I think the US will have to. Looks like the epic blow off top incoming is still alive, maybe aud will follow that some more.