Australian dollar fatally linked to China

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Macro Afternoon

MUFG with a solid take on AUD:

USD continues to correct lower as Fed fails to deliver another hawkish surprise29thJuly2021USD: Gradual QE taper plans encourage further correction lower for USD

The US dollar has continued to correct lower following last night’s FOMC meeting with the dollar index falling further below the intra-day high of 93.191 recorded on 21st July. After moving back within touching distance of the year to date high from the end of March at 93.437, the US dollar has lost upward momentum over the past week. Last night’s FOMC meeting failed to provide the fresh bullish trigger required to regain upward momentum in the near-term. The Fed’s latest policy update was largely in line with expectations. The updated policy statement signalled that the Fed is moving closer to tapering QE by acknowledging that the US economy has made“progress” towards their goals, and that the FOMC will continue to assess progress in the coming meetings. The Fed has been encouraged that indicators of economic activity and employment have continued to strengthen. Sectors of the economy most adversely affected by the pandemic have shown improvement but have not yet fully recovered. However despite the progress, Fed Chair Powell reiterated that “we’re notthere yet and we see ourselves as having some ground to cover to get there”.

Overall, it highlights that the Fed is clearly guiding the market to expect a gradual tapering process which could begin later this year/early next year. The likelihood of the Fed starting the tapering process earlier in September appears to have diminished somewhat. Chair Powell promised plenty of advanced warning before any decision on tapering as the Fed attempts to dampen the risk of any financial market disruption from the tapering process. He also signalled that the Fed is likely to begin scaling back US Treasury and MBS purchases at the same time. There was “little support for tapering MBS earlier than Treasuries”.Further details of the QE tapering discussions will be revealed in the release of the accompanying minutes on 18th August just ahead of Fed Chair Powell’s much anticipated Jackson Hole speech at the end of August. The Fed’s plans for gradual QE tapering should help to dampen upside risks for the US dollar in the near-term.The Fed announced as well that it has established two standing repurchase-agreement facilities, domestic(SRF)and foreign(FIMA repo facility), that will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning. Under the FIMA repo facility, the FOMCdirected the Desk to offer overnight repo transactions at a rate of 0.25 percent to foreign central bank and international accounts against their holdings of Treasury securities maintained in custody at the New York Fed, subject to a per-counterparty limit of USD 60 billion. It should help to dampen upward pressure on the US dollar during periods of market stress.

AUD: China growthconcernsreinforceAussie’s recent woesThe softer US dollar overnight is also a reflection of some easing of concerns over recent negative developments in China. The Shanghai composite index has rebounded by almost 3% from yesterday’s point but still remains around-4.5% below last week’s highs. The reversal in CNY is more complete with USD/CNY back trading within the 6.4500 to 6.5000 that has been in place since mid-June after briefly rising above 6.5000 earlier this week. The PBoC added CNY30 billion of liquidity into the financial system overnight through seven-day reverse repurchase agreements. China’s securities regulator also convened executives of major investment banks in an attempt to ease market fears about Beijing’s regulatory crackdown. Bloomberg reported that several bankers left with the message that the education policies were targeted and not intended to hurt companies in other industries. China’s official Xinhua News Agencyreportedas well that recent policies targeting internet platforms and after-school tutoring are aimed at protecting online data security and social welfare rather than outright curtailing those industries.

Finally, CNBC has reported overnight that China will continue to allow companies to go public in the US as long as they meet listing requirements. Cross-border stock listings can also occur using the variable interest entity structure. While the latest developments provide some reassurance, we expect China growth concerns to remain in focus for market participants. It has been one reason why the Australian dollar has underperformed recently falling back to a recent low of 0.7290against the US dollar. At the same time, the Australian dollar’s recent underperformance reflects the loss of domestic cyclical momentum in response to renewed COVID restrictions in Australia. The Australian economy is still expected to expand modestly in Q2 but could contract again in Q3. It should though prove to be only a temporary setback for Australia’s economy which has fared better than most in the face of the COVID shock. Real GDP had already surpassed the pre-pandemic peak in Q1 and the unemployment rate has fallen to its lowest level (4.9%) since the end of 2010. The temporary economic slowdown has encouraged expectations that the RBA will announce a dovish policy shift at next week’s meeting on 3rd August. The RBA is expected to shelve plans from their last meeting (6th July) to begin slowing the pace of QE purchases from September to AUD5 billion/ week to AUD4billion. There is even a building risk that the RBA now feels the need to provide more policy support and temporarily steps up the pace of weekly QE purchases. The dovish policy shift would widen the near-term policy divergence between the RBAand RBNZ. The RBNZ recently brought a more abrupt end to their QE programme and set the stage for rate hikes at upcoming policy meetings. As a result, we have recommended a short AUD/NZD trade idea in our latest FX Weekly (click here) and expect the pair to test the low from last December at 1.0418.

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