We downgrade AUD from 0 to -1 vs USD on domestic risks and monetary policy divergence. AUD is particularly exposed to two of the major factors roiling markets: FOMC policy tightening and trade war risk.
Following the FOMC’s rate hike last month, the RBA cash target rate is lower than fed funds for the first time in almost 20 years. The last time this happened, in the late 1990s, AUD lost one-third of its value against USD. In the 1990s the gap reached 50bp in favour of fed funds; based on market expectations of monetary policy this year the gap could widen to at least 75bp this time. The 2y yield spread is already at -50bp, and could yet test the 1990s level of -100 bp. In our Macro Strategy portfolio we own AUD/USD downside through a calendar put spread, betting that AUD will react to this erosion of yield support by the end of the year.
External demand for Australian commodities at risk. We expect Chinese GDP growth to slow moderately this year, to 6.5%, due mainly to a cooling housing market. This implies reduced demand for Australian iron ore. Sure enough, prices have already dropped 20% since the end of February.
Online retail market share rising. Amazon Australia started trading in December. According to the latest figures, online retail turnover in Australia has increased by 40% since February 2017, In Germany, the UK and the US, where online retail sales are around 14% of the total, the Amazon effect has produced high street price disinflation and weakened the Phillips curve. The prospect of something similar happening in Australia is likely to stay the RBA’s hand, lending further support to our AUD downgrade from 0 to -1.
AUD/USD spot was 0.78 at the time we made the call. Our Asset Allocation recommendations have a 3 to 6 month time horizon. Over 3 months AUD had fallen 5% vs. USD and this deepened to 9% over 6 months.