AUD/USD: 2019 Economic Recap and Risks Ahead for 2020

Australia

Domestic Economy and Monetary Policy

In 2019 the outlook for the Australian economy reached a turning point as the housing decline began to create a negative wealth effect, which sapped consumer confidence, retail sales, employment gains and ultimately GDP growth[1]. When the RBA made back to back cash rate cuts in June and July, consumer and business confidence quickly entered a downtrend as the RBA and economists announced more concerned views that conflicted with that of the overly optimistic Federal government[2]. As the more pessimistic outlook for the domestic economy played out throughout 2019 the AUD weakened alongside it, helped along by the to-and-fro of the US-China trade war[3].

While the lower AUD has supported Australian export growth, the further easing required from the RBA to accommodate further is still a topic of great debate going into 2020. The RBA cut once again in October to 0.75% and markets are pricing in another cut at some point in 2020, as while there has been some improvement in the labour market data, headwinds remain when looking forward for the Australian economy[4]. As the RBA is nearing the effective lower bound of the cash rate (the point in which there is no added benefit to further cuts, not necessarily 0%), there has been growing talk amongst pundits of the potential for an RBA quantitative easing program, to artificially lower the theoretical risk free rate derived from Australian government bonds to stimulate credit growth. The consensus for the cash rate floor was originally 0.5%[5] (as even at 0.75% banks barely passed on the cut to mortgage holders), but in a consequential speech in late February RBA Governor Phil Lowe said that “QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that.[6]” The market quickly readjusted to the possibility of a cash rate lower than 0.5%. Multiple banks including JP Morgan and Westpac still have of QE included in their expectations for the near future, predominantly due to their belief that the RBA’s targeted full unemployment rate of 4.5% will not be met without further easing amidst a slowing global economy[7].

Risks ahead

Further risks looking ahead for the Australian economy include the recent bushfire crisis and the potential redirection of trade flows following the signing of the phase one trade deal between the US and China.

The extent of the impact of the bushfires upon Australian economic activity is still under debate amongst economists, due to the uncertainty stemming from the lack of datapoints. While the GDP output of the affected areas is less than that of a capital city, many of them rely on domestic tourism which has understandably suffered this year. The international press accompanying the fires has also led to widespread cancellations of foreign tourist trips to areas not affected by the fires; some travel agencies catering to Chinese tourists estimate that up to 30% of trips may be cancelled, citing a growing perception that Australia is no longer a safe destination with clean air[8].  With tourism being Australia’s third biggest export valued at close to AUD70b annually, the economic fallout of the fires has become another potential headwind faced by the domestic economy[9].

The US-China ‘phase one’ trade deal could also present a risk to the Australian economy and AUD, due to the potential shifts in trade flows away from Australia and towards the US[10]. The trade deal signed on 15 January 2020 included a Chinese commitment to purchase an additional USD200b of US exports than it did in 2017, ranging from agricultural products and animal proteins to LNG and crude oil[11]. In 2019 Australia was the biggest exporter of LNG to China, and if this volume was redirected to the US Australian exporters could suffer[12].

One factor that could mitigate these risks and the weak domestic economy is the recent housing recovery. Sydney and Melbourne houses are up 6.8% and 8.7% respectively year-on-year, and this could reverse the negative wealth effect that took place in 2018 and early 2019 and boost consumer spending[13]. Property markets around the country have rebounded off the back of cheaper credit and the Liberal government’s federal election win and a subsequent renewal in investor confidence[14]. Understandably there is a delay between higher prices and higher consumer spending, so that is one of the main uncertainties for the Australian economy in 2020 – the extent of the recovery and how it will influence the prospects of further easing from the RBA.

 Source: Bloomberg, data extracted 28 January 2018

United States

Domestic Economy and Monetary Policy

2019 for the US economy featured a Federal Reserve that pivoted from a hawkish to dovish stance on monetary policy, as the US economy slowed yet still prolonged the economic expansion to make it the longest in US history[15]. US manufacturing slipped into contractionary territory in Q3, with the resilient American consumer sustaining the economy through the long-awaited wage growth fuelling spending[16].

Source: Bloomberg, data extracted 28 January 2020

Risks ahead

While the Fed is not expected to be as active in adjusting the Fed funds rate in 2020 as they were in 2019, there are several risks to the USD that the market is watching for in 2020[17].

Global reflation is one of these risks and refers to the return of economies around the world to higher growth and equity returns, and thus the end of the US dominance that has taken place since the 2018 Trump tax cuts. As foreign assets become more attractive, this could lead to investors liquidating some of their USD denominated positions and reinvesting the proceeds overseas[18].

Another tail risk noted by analysts is that if a progressive Democratic candidate such as Elizabeth Warren or Bernie Sanders secures the Democrat nomination and wins the presidency in the November 2020 election[19]. The policy platforms of both candidates include higher taxes for the wealthy and corporates, as well as greater regulations which should have a negative impact upon equities and economic growth prospects[20]. Thus, there could be some degree of capital flight from US assets, amplifying the aforementioned reflation trade. Bank research teams note that this added risk could last throughout the year, starting at the Iowa Caucus on February 3rd[21]. Trump is expected be the Republican candidate because while he was technically impeached by the House of Representatives in December 2019, he would need to be convicted by the Republican-controlled Senate to lose office (currently in progress, but not expected to eventuate)[22].

A more systemic risk facing the US economy which could adversely affect the USD is the current turmoil in the domestic repo market. Repurchase agreements (or repo’s) are a way for financial institutions to obtain overnight liquidity for funding purposes by temporarily posting collateral – usually in the form of US treasuries. Multiple times towards the end of 2019 the demand for this funding far outmatched supply and led to the overnight rate jumping to as much as 10% one day in September. To counteract this the Federal Reserve entered the repo and short-term money markets on 11 October to provide liquidity at a fixed rate where required and to suppress Treasury bill yields, however this is not intended to be a permanent fix to the liquidity issues. As these actions have led to an expanding Fed balance sheet, whether this constitutes quantitative easing or not is a matter of ongoing debate. However, pundits believe that this other form of accommodative policy is a partial cause of why the S&P500 rose 8.5% and DXY (US dollar index) declined 2% for the rest of 2019. As the Federal Reserve looks to eventually wind back these operations later in the year, there’s a risk markets will react violently when the underlying liquidity support dissipates.

Further Risks Abroad

The ongoing coronavirus health scare in Wuhan, China presents a developing risk for investors and those with FX exposures, due to how it could potentially slow economic activity in a similar way to how the SARS virus did in 2003[23]. As of 28 January, the official death toll has reached 106, the number of infected has surpassed 4500, and travel out of Wuhan and neighbouring cities has been suspended[24].

Another potential risk this year is the reignition of tensions in the Middle East after recent events between the US and Iran. While these have subsided, if clashes between the US and anti-US militia groups (the catalyst for the recent turmoil) continue, tensions could reignite and create oil price shocks – an inhibitor for global growth[25].

AUDUSD Forecasts:

Considering the myriad of risks faced by Australia, the US, and the global economy, below are some forecasts for the AUDUSD exchange rate:

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[1] Mousina, D. (2019). The wealth effect and the impact on consumer spending | AMP Capital. [online] AMP Capital. Available at: https://www.ampcapital.com/au/en/insights-hub/articles/2019/march/econosights-the-wealth-effect-and-the-impact-on-consumer-spending [Accessed 24 Jan. 2020].

[2] Wright, S. (2019). That’s a courageous call about the economy, Prime Minister. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/politics/federal/that-s-a-courageous-call-about-the-economy-prime-minister-20190411-p51d2k.html [Accessed 24 Jan. 2020].

[3] Jamieson, C. (2019). Ongoing trade war could push AUD below 60 cents – how could investors potentially profit from this?. [online] Investordaily.com.au. Available at: https://www.investordaily.com.au/analysis/45731-ongoing-trade-war-could-push-aud-below-60-cents-how-could-investors-potentially-profit-from-this [Accessed 24 Jan. 2020].

[4] Chalmers, S. (2019). Is 2020 the year Australia’s record-breaking economic run ends in recession?. [online] ABC News. Available at: https://www.abc.net.au/news/2019-12-23/where-economists-see-australia-in-2020-lower-rates-slow-growth/11796280 [Accessed 24 Jan. 2020].

[5] Joye, C. (2020). The RBA is one meeting away from quantitative easing. [online] Australian Financial Review. Available at: https://www.afr.com/policy/economy/the-rba-is-one-meeting-away-from-quantitative-easing-20191001-p52woe [Accessed 24 Jan. 2020].

[6] Lowe Governor, P. (2020). Unconventional Monetary Policy: Some Lessons From Overseas | Speeches. [online] Reserve Bank of Australia. Available at: https://www.rba.gov.au/speeches/2019/sp-gov-2019-11-26.html [Accessed 24 Jan. 2020].

[7] Westpac Institutional Bank (2020). Westpac expects Reserve Bank of Australia and US Federal Reserve to delay rate cuts. Bulletin. Westpac.

[8] Heath, M. (2020). Chinese Tourists Cancel Trips to Australia After Wildfires. [online] Bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2020-01-17/fire-fallout-another-blow-for-australia-as-chinese-cancel-trips [Accessed 24 Jan. 2020].

[9] Heath, M. (2020). Chinese Tourists Cancel Trips to Australia After Wildfires. [online] Bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2020-01-17/fire-fallout-another-blow-for-australia-as-chinese-cancel-trips [Accessed 24 Jan. 2020].

[10] Greber, J. (2020). Trump deal spells pain for Australian exporters. [online] Australian Financial Review. Available at: https://www.afr.com/world/north-america/some-pain-for-australian-exporters-from-trump-trade-deal-20200116-p53s0l [Accessed 24 Jan. 2020].

[11] Politi, J. (2020). What’s in the US-China ‘phase one’ trade deal?. [online] Ft.com. Available at: https://www.ft.com/content/a01564ba-37d5-11ea-a6d3-9a26f8c3cba4 [Accessed 24 Jan. 2020].

[12] Greber, J. (2020). Trump deal spells pain for Australian exporters. [online] Australian Financial Review. Available at: https://www.afr.com/world/north-america/some-pain-for-australian-exporters-from-trump-trade-deal-20200116-p53s0l [Accessed 24 Jan. 2020].

[13] Burke, K. (2020). Australia’s median house price rising back to peak levels as key markets rebound: Domain House Price Report. [online] Domain. Available at: https://www.domain.com.au/news/australias-median-house-rising-back-towards-peak-prices-as-key-market-rebound-922435/ [Accessed 24 Jan. 2020].

[14] Chau, D. (2019). Property prices rebound, led by Sydney and Melbourne spring sales. [online] ABC News. Available at: https://www.abc.net.au/news/2019-10-01/property-price-rebound-sydney-melbourne-corelogic/11562824 [Accessed 24 Jan. 2020].

[15] Li, Y. (2019). This is now the longest US economic expansion in history. [online] CNBC. Available at: https://www.cnbc.com/2019/07/02/this-is-now-the-longest-us-economic-expansion-in-history.html [Accessed 24 Jan. 2020].

[16] Siegel, R., Bhattarai, A. and Long, H. (2019). American consumers are holding up the global economy. But for how long?. [online] Washington Post. Available at: https://www.washingtonpost.com/business/economy/american-consumers-are-holding-up-the-global-economy-but-for-how-long/2019/08/17/9eb20740-c066-11e9-a5c6-1e74f7ec4a93_story.html [Accessed 24 Jan. 2020].

[17] CME Group. (2020). CME FedWatch Tool: Countdown to FOMC – CME Group. [online] Available at: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html [Accessed 24 Jan. 2020].

[18] Guy, R. (2019). Global reflation, not upbeat RBA driving $A rally. [online] Australian Financial Review. Available at: https://www.afr.com/markets/equity-markets/global-reflation-not-upbeat-rba-driving-a-rally-20191106-p537un [Accessed 24 Jan. 2020].

[19] UBS (2020). 2020 US election & markets: It’s complicated. Macro Monthly. [online] UBS, pp.1-2. Available at: https://www.ubs.com/au/en/asset-management/insights/market-update/2019/macro-monthly/_jcr_content/mainpar/toplevelgrid/col1/actionbutton.0966858896.file/bGluay9wYXRoPS9jb250ZW50L2RhbS9zdGF0aWMvYXNzZXRfbWFuYWdlbWVudC9hdXN0cmFsaWEvaW5zaWdodHMvbWFjcm8tbW9udGhseS1qYW4tMjAyMC5wZGY=/macro-monthly-jan-2020.pdf [Accessed 24 Jan. 2020].

[20] Li, Y. (2019). Stock market at record finds a new foe: ‘Elizabeth Warren is the new Wall of Worry’. [online] CNBC. Available at: https://www.cnbc.com/2019/11/07/stock-market-finds-foe-elizabeth-warren-is-the-new-wall-of-worry.html [Accessed 24 Jan. 2020].

[21] UBS (2020). 2020 US election & markets: It’s complicated. Macro Monthly. [online] UBS, pp.1-2. Available at: https://www.ubs.com/au/en/asset-management/insights/market-update/2019/macro-monthly/_jcr_content/mainpar/toplevelgrid/col1/actionbutton.0966858896.file/bGluay9wYXRoPS9jb250ZW50L2RhbS9zdGF0aWMvYXNzZXRfbWFuYWdlbWVudC9hdXN0cmFsaWEvaW5zaWdodHMvbWFjcm8tbW9udGhseS1qYW4tMjAyMC5wZGY=/macro-monthly-jan-2020.pdf [Accessed 24 Jan. 2020].

[22] Wolfe, J. (2020). Explainer: How impeachment works and why Trump is unlikely to be removed. [online] Reuters. Available at: https://www.reuters.com/article/us-usa-trump-impeachment-explainer/explainer-how-impeachment-works-and-why-trump-is-unlikely-to-be-removed-idUSKBN1Z10PT [Accessed 24 Jan. 2020].

[23] Murtaugh, D. (2020). Commodity Investors Recall SARS as They Tally Toll of New Virus. [online] Bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2020-01-22/commodity-investors-recall-sars-as-they-tally-toll-of-new-virus [Accessed 24 Jan. 2020].

[24] Bloomberg.com. (2020). WHO Chief Heads to China as Virus Death Toll Tops 100. [online] Available at: https://www.bloomberg.com/news/articles/2020-01-27/who-chief-heads-to-china-as-efforts-to-contain-virus-accelerate?sref=92Is2d7a [Accessed 28 Jan. 2020].

[25] Ft.com. (2020). Risks of US-Iran conflict will not quickly subside. [online] Available at: https://www.ft.com/content/dbdaeab8-3228-11ea-a329-0bcf87a328f2 [Accessed 24 Jan. 2020].