The Australian Dollar’s decline accelerates
US CPI data suggest that inflationary pressures are ramping up. The cost of energy, food and used cars are all a burden on the average consumer. Looking across to the world’s second-largest economy in China, the data suggests their inflation is not running as hot, as it has been under 1.0% since October 2020.
There is a disconnect between what the commodity prices are telling us and recent economic activity from China, which themselves are the largest consumer of base metals. The Chinese economy grew by a seasonally adjusted 0.6% in the three months to March 2021 disappointing market expectations of a 1.5% expansion. The disconnect in elevated prices is due to a shortage of supply and continued disruption to supply chains.
Due to the increasing usages and demand for copper, the metal becomes a good barometer of global activity. So, when it falls, traders and investors take note.
Copper prices fell on Monday as signs of weakening demand from top consumer China weighed on sentiment. Tuesday’s price action attempted to regain the all-time highs but failed to do so. Yesterday’s price action following the US CPI data has now brought the price of copper back down and we’re likely to see lower prices unless the inventories of the London Metal Exchange worsen, and consumption rises.
Investors get spooked when they see rising inflation because if inflation runs higher than the return of their portfolio, the portfolio actually returns a negative real return. This is why interest rates generally rise as low-interest rates compared to rising inflation means, savers see a reduction of their wealth. The Central Banks have attempted to get savers to become consumers with low-interest rates for a couple of decades now, but the uncertainties in the economy haven’t increased spending as much as the policymakers would like.
If copper is signalling a top in the commodity markets, that is not good for the likes of the Australian economy. If the US inflation rate runs hot for a sustained period of time, US rates will rise, and the US dollar will follow suit, as money moves into the greenback on positive rate differentials. This combination of macroeconomics would signal a bearish Australian dollar versus the US dollar.
The daily chart of the AUDUSD shows that prices have been in a fairly tight range since the 25th February highs. From a longer-term perspective, traders will be noticing that the recent run-up in the AUDUSD when the greenback was depreciating, has peaked below the February highs by some margin and we look to be forming a lower swing high, and possibly a head and shoulders pattern. A close below the neckline of the H&S pattern and the 0.7580 price level would signal the completion of the chart pattern and the projected price to the downside would be around 0.7150 for a measured move or worst-case scenario, 0.6720 for an x2 measured move, which often happens from a major topping pattern.
Looking at a chart that compares the price of copper to the AUDUSD or (AUDJPY) and US10y02y yield curve shows how the Australian dollar tracks the inflation expectations and rising commodity prices.
Back in March 2020 the US 10y2y yield curve spiked higher, as the Federal Reserve and central banks globally put a floor in the markets with massive monetary stimulus. The expectations in the yield curve when it shows a steepening is a stronger economic activity and rising inflation expectations, and thus, higher interest rates. After that jump higher in the yield curve, the rise has been steadily moving along with the rise in copper price and the AUDJPY has matched the move quite tightly.
Over the course of the next few months, the Federal Reserve will want to see sustained inflation above 2%, if the CPI and PCE drop the Federal Reserve will keep monetary policy loose, and the yield curve will likely adjust lower. This would bring the US dollar down and the AUDUSD should be saved from a major correction.
The risk is that while US inflation expectations are rising, the ongoing pandemic disruptions don’t allow China to fully expand their economic activity and therefore creates uncertainty around sustained commodity demand. Plus, there are rising political challenges between the Australian and Chinese governments, which has resulted in a reduction of exports to China from Australia.
In the February Reserve Bank of Australia monetary policy statement, the RBA board stated “In the near term, some momentum in the global economy has been lost, as infection rates have surged in a number of economies and lockdown measures have again become necessary. The recovery is likely to be bumpy and uneven and dependent both on the health situation and ongoing fiscal and monetary policy support. Spare capacity will remain for some years, dampening inflationary pressures.”
Because of the uncertainties, the RBA are keeping their rate at 0.100%, so already well below the Feds 0.250%.
In today’s forex markets the Australian dollar is weaker against the other major currencies, whereas the Japanese yen is catching a bid. The daily charts for both the AUDUSD and AUDJPY show that the last few days have been particularly bad for the Australian dollar, but the AUDJPY is now testing the first level of significant support.