By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Here’s 3 Reasons Why AUD Broke 70 Cents
Since the beginning of the year, the Australian dollar has been one of the worst-performing currencies. On Wednesday, AUD/USD added more than 1% to losses that now top 14% year to date. The decline has been extensive with the Australian dollar worth significantly less versus the Swiss franc, Japanese yen, British pound and euro in September compared to January. Unfortunately for Australians, the lack of desire to own the currency has more to do with external than domestic factors. The primary source of weakness stems from China, the country’s largest trading partner. Not only has growth in Asia’s largest economy been slowing, but the devaluation in August reduces the purchasing power of Chinese businesses and investors. That has a direct impact on key parts of Australia’s economy including the mining industry and housing market.
The Australian dollar dropped below 70 cents intraday due to the persistent slowdown in Chinese manufacturing activity. On Tuesday night a private survey compiled by Caixin found manufacturing activity contracting at the fastest pace since March 2009. If Chinese factories are operating at a slower pace, they will have less demand for Australian resources. Commodity prices have fallen in response and the 3.6% drop in copper prices contributed to the currency's decline. In the past 4 days alone, copper prices have fallen 8%. The third factor that contributed to the break of 70 cents is the U.S. dollar. Investors are piling back into the currency on the belief that the Federal Reserve will still raise interest rates this year.
The U.S. dollar traded higher against all of the major currencies Wednesday with the exception of the euro. An uptick in mortgage approvals and steady manufacturing activity reinforced the market’s positive outlook on the currency. The recent slowdown in the Richmond Fed, Empire State and Philly Fed surveys signaled a potential downside surprise in the national report. However instead of falling, the Markit US Manufacturing PMI index held steady at 53. U.S. yields also ticked higher and the simultaneous drop in U.S. stocks, rise in the dollar and yields confirms that rate-hike expectations helped to keep the greenback supported.
The euro tortured longs and shorts on Wednesday. Despite a decline in the German and Eurozone PMIs, the euro traded higher for the first time in 4 days, leading investors to wonder if it has reached a near-term bottom. The main focus was on Mario Draghi’s speech and while he echoed the views of his peers in saying that QE could be extended if needed, the euro responded positively because he sounded slightly more optimistic about the outlook for the economy. More specifically, Draghi sees inflation rising toward the end of the year and indicated that it's too early to tell if the latest weakness will last. Later, ECB member Weidmann described the euro area recovery as solidified suggesting that he would not support further stimulus. We had been looking for a lower EUR/USD, which did not materialize on Draghi’s comments. But if the currency pair bounces to 1.13, we view the move as an attractive place to renew short positions.
The British pound was also hit hard. The velocity of the move given the supportive comments from U.K. policymakers surprises us. Wednesday afternoon, BoE member Broadbent said he sees easing of factors weighing on U.K. wages, which is in line with the views of other policymakers who feel that rising wages is a big problem for the economy and one that could necessitate tighter monetary policy. In the short span of 4 trading days, GBP/USD has fallen more than 400 pips from high to low and there is no support until the September low of 1.5164.
USD/CAD hit its highest level in 11 years Wednesday on the back of lower oil prices prices and weaker data. Retail sales in Canada rose 0.5% in July, which was less than the market expected. The miss would not have been so bad if retail sales ex autos did not stagnant. Spending in June was also revised lower and oil prices dropped 4%, adding to the pressure on the currency.
The New Zealand dollar joined the decline. No economic data was released but the country’s trade balance was due Wednesday evening. Lower dairy prices in early August are expected to drive the trade deficit higher, which could extend NZD losses.
Japanese markets were set to re-open Wednesday night and with it comes the PMI manufacturing report. Activity is expected to slow as the positive impact of Abenomics begins to fade.