Fed hikes priced into AUD outlook as AUD undercut by USD

The Australian dollar (AUD) has fallen sharply against its US counterpart, the greenback. The AUD ticked below 0.72 overnight following the release of weaker than expected employment figures for May, which managed to break 1 million for the first time in more than a year. The jobless rate unexpectedly rose fractionally to 5.6 percent, while the number of underutilized or idle workers reached a record high of 360 thousand in May 2016.

Interest rates were also hiked overnight by the US Federal Reserve as they anticipated further weakness in global markets, paving way for a sharp drop in USD/AUD and a spike in AUD/USD across forward premium contracts before markets opened this morning (Australia time).

The AUD/USD

Pair traded at 0.7230 as of 10:55 am AEST, while the USD/JPY was trading at 111.37, giving a slight change in tone to the overnight “sell-off”. This weakness did not stop investors from taking a quick profit, however, as AUD/USD rose to 0.7245 by mid-morning in Sydney. The greenback has already embarked on a sharp rally this morning as it trades for its highest level since early January 2015.

The AUD/USD pair rose a strong 0.13 percent to 0.7235 in response to the RBA’s decision to keep its cash rate steady at 1.5 percent, albeit indicating that further interest rate cuts are likely in the future as inflation remains well below their target 2-3 percent range. An earlier-than-expected rise in US rates also put downward pressure on the Aussie, particularly after the release of weaker than expected Australian NAB business conditions indicator (mentioned below).

Upward pressure

It could arrive from the release of interest rate decisions from the European Central Bank (ECB) and the Bank of Japan (BOJ) later today. The ECB is also expected to hint at a rate cut in its statement today, also the BOJ is likely to leave its policy unchanged.

The USD/JPY pair rose 0.41 percent to 111.43 overnight, with the market now anticipating further weakness in the yen over the near term following Japan’s surprising snap election last week.

The Kospi closed 0.95 percent lower to 1,971.75 overnight as the South Korean won (KRW) fell to its lowest level against the greenback in over four months. The Aussie fell 0.84 percent against the South Korean won (KRW) to close at 1,322.15, while the AUD/KRW pair rose 0.26 percent to close at 1081.13 after rising as high as 1087 following earlier market weakness in Asia overnight and some positive economic reports from China this morning regarding industrial production for June.

Why are we seeing a lower AUD/USD?

The US interest rate hike has provided the downward impetus for AUD/USD at 0.7245. The Aussie is now trading at its weak level since January 2015, and this may continue if US rates rise further and Australia’s central bank is forced to cut its own rates in response: this will cause further weakness in the Australian dollar against the USD.

What are the key drivers of AUD?

Australia is heavily dependent on China, which accounts for more than one-third of its exports. Australia’s economy grew at 0.3 percent in Q1, 2016, and its job market is weakening as it climbs out of the mining slump. Commodity exports (including coal and iron ore) are experiencing a soft patch, while demand for services is increasing. The Reserve Bank of Australia has begun cutting interest rates, but this will not be enough to prevent the Australian dollar from falling further against other major currencies due to China’s economic slowdown and the US interest rate hike.

What are the short-term prospects for AUD?

The Australian dollar fell to its lowest level since Jan 2015 against the greenback following the US interest rate hike and could fall to levels of around 0.67 if the US Fed continues to lift rates. This will happen due to Australia’s weak economic figures and because China is facing an economic slowdown, which will increase downward pressure on AUD in the near term.

What are the medium-term prospects for AUD?

The Australian dollar will probably remain weak over the medium term due to slowing growth in China and other emerging countries. Interest rate hikes by the RBA may also continue if these pressures persist, which will impact negatively on AUD’s value against other currencies. The Australian economy has been growing at a fairly modest rate, but it is expected to slow further as the economy adjusts from a once-in-a-century mining boom.