FX Weekly Update 28 Aug 2020

The Week in Review

The AUD steadily ground higher this week, opening Monday around 0.7160 to the current 0.7260. It reached a fresh recent high of 0.7290 – a level last seen in January 2019. This was largely due to upbeat risk sentiment – US equities hit record high after record high, with the S&P500 closing Thursday night at 3484 (up 2% for the week). The ASX did not enjoy the same success, currently down roughly 0.6% for the week. Many banks have also raised their AUDUSD forecasts for 2020 & 2021 due to widening interest rate differentials and a rebounding Chinese economy. Westpac is among them, now calling for a 0.75 handle by the end of 2020, and 0.80 by the end of 2021. There was a historic change to the Federal Reserve’s policy framework revealed overnight, although for the most part it was a quiet news week.

AUDUSD

Federal Reserve

In a widely anticipated speech held overnight, Fed Chair Jerome Powell gave markets a rundown over the Fed’s new policy framework around inflation and unemployment.

The two main changes are:

– Instead of targeting 2% inflation, the Fed will target a 2% average inflation rate over time. This is due to the US economy’s consistent failure to reach the target and implies that the Fed will let the US economy run hot with higher inflation before considering hiking rates to curtail it. The St Louis Fed President James Bullard said in an interview with Bloomberg that they’d play catchup with inflation, “If you wanted to stay on the price-level path that was established from 1995 to 2012 you could run 2.5% inflation for quite a while.”

– They have adjusted the language around their employment goals: they will assess “shortfalls of employment from its maximum level” instead of “deviations from its maximum level”. By focussing on “shortfalls” instead of “deviations”, they’re de-emphasising previous concerns that if unemployment is too low it can cause excess inflation. This was part of the reason why the Fed was hiking rates at a rapid pace in 2018 – the job market was at its best in 50 years and there were concerns inflationary pressures would build. With this change in language, should a similar situation arise the Fed may be less willing to raise rates.

The takeaway: Low interest rates in the US are likely here to stay for some time.

Looking ahead: Market pundits expect there to be some additional forward guidance in the September Fed meeting, so that will be the next main driver of inflation/ rates expectation.

The Week Ahead

Key events to watch for next week:

  • Jackson Hole Symposium (over the weekend)
  • RBA Meeting and Policy Announcement
  • Australian Q/Q GDP (Wednesday morning)
  • US unemployment rate and labour market data (Friday night)

References

Evans, B., 2020. AUD Forecasts Lifted To USD 0.75 End 2020 And USD 0.80 End 2021. [online] Westpac Institutional Bank. Available at: <https://www.westpac.com.au/docs/pdf/aw/economics-research/WestpacWeekly.pdf> [Accessed 28 August 2020].

Torres, C., Condon, C. and Matthews, S., 2020. Fed Paves Way For Low-Rate Era With Inflation Able To Run Higher. [online] Bloomberg.com. Available at: <https://www.bloomberg.com/news/articles/2020-08-27/powell-says-fed-to-seek-inflation-that-averages-2-over-time> [Accessed 28 August 2020]