The Australian dollar has been one of the worst performers among major currencies this year due to a combination of domestic weakness and external risk factors. Voices have been rising to step up proactive policies to support the economy. Will measures be strong enough to send a signal to the markets and turn sentiment around? In this report we will take a look at key challenges the economy has to face in 2020, as well as factors that will drive the exchange rate.
Growth revised down for 2020
Australia’s GDP growth has been recovering since its low point in 2018, and the economy expanded moderately in 2019. However, the International Monetary Fund (IMF) has lowered its forecast for growth in 2020 from 2.8% to 2.3%, as major structural issues remain to be tackled.
Good news first. The labour market has been resilient despite extended period of slowdown. Employment has continued to expand with the participation rate reaching record highs this year. The unemployment rate has been low and steady near 5%. Though growth in wage has been dragging.
Another bright spot is the recovery of the housing market. After a steep decline in 2018 in major cities, the turnaround proved to be faster-than-expected. Rising housing prices provide support to consumer confidence and housing-related inflation.
Now the bad news. Inflation has remained muted with the CPI at 0.3% in the last quarter and 1.7% so far into the year. Core inflation is expected to pick up gradually in 2020, to about 2%. But how this target can be effectively achieved is still a heated debate among policymakers. Protracted period of weak inflation may eventually push the Reserve Bank of Australia to extend its expansionary measures.
In its monetary policy review in November, the RBA was dovish enough to slash economic forecasts and hinted at deeper rate cuts next year. Should growth remain subdued, the central bank would roll out extraordinary policies including negative interest rates and large-scale quantitative easing. Nevertheless, the RBA warned "policy stimulus might be less effective than past experience suggests". We could expect further pressure on the Australian dollar should rate cuts deepen.
In conjunction with a loose monetary policy, the government is asked to take decisive action via a fiscal package. The Liberal-National government may need to give up its aim for budget surplus for the first time in more than a decade in order to boost infrastructure spending. Will policy stimulus be strong enough to offset the negative impact from weaker external demand?
Exchange rate subject to global trade conditions
Misfortunes come in pairs. Australia will have to continue to embrace uncertainty from global slowdown. With its economy highly sensitive to commodities exports, rising trade barriers and increasing geopolitical tensions can only add fuel to the fear of recession.
Australia’s economy and by extension its currency have their fates intertwined with China – its largest trading partner with 29.2% of total Australian exports in 2018. The world’s second largest economy is still tangled up in trade disputes with the US, and it is expected to grow at a mere 5.8% in 2020. The slowdown is definitely leaving a mark on its Australian counterpart. Trade wars have driven the Australian dollar to historic lows and this is likely to carry on unless true de-escalation happens.
AUDUSD looks for rebound catalyst
The pair is still in the long-term bearish trend established from 2013. The two-year-long correction between 2016 and 2018 struggled to lift the price higher and reverse the trend. The current round of sell-off will last as long as the price remains below the resistance-like moving averages.
We see stabilisation in the exchange rate in the shape of horizontal consolidation from August 2019. A rebound above the averages and the bearish trend line could boost buyers’ morale and prompt sellers to cover their positions. A positive catalyst on the fundamental side may send the pair to 0.7400. The downside risk would be a break below 0.6700 which could push the pair towards its 11-year lows at around 0.6300.
AUDJPY remains under water
The Aussie will move in sharp contrast to the yen’s safe-haven currency status. The pair is currently in the third phase of the downtrend from November 2014. The rebound from the lows of the 2018 flash crash is likely to run into resistance against the bearish trend line.
The psychological level of 76 is the first major supply zone where we would expect stiff selling pressures. A break above it may trigger an extended rally towards 80.50 or even 83 in a fourth corrective wave. Sentiment would remain on the bearish side unless there is an upbeat shift on the fundamental side, which means should 70 fail to support the price we could see a gradual drop towards 67.