US economic data continues to improve, and that doesn’t bode well for the recent strength in the Aussie dollar.
Although the AUD has dipped from its recent highs above US80 cents, it’s still up by around 9% against the greenback this year.
However, Citi analysts point out that the recent turnaround in the bank’s US Economic Surprise index (ESI) could have further to run.
In a research note called “It’s (still) the economy, stupid”, Citi’s technical strategists note that the ESI has recently climbed from a low of almost -80 back to -40.
Not only that, but based on prior technical patterns, it looks like it’s poised to climb further.
This chart tells the story:
The Aussie dollar’s climb from US75c to US80c has been due in part to the market’s hawkish interpretation of recent statements from the RBA.
Political turmoil in Washington, which has pushed back the implementation of the Trump administration’s pro-growth agenda, has also helped to boost the Aussie against its US counterpart.
But a consistently bad run of US data has caught markets by surprise this year, and contributed to more weakness in the greenback against most major currencies.
Inflation has remained soft and Q1 GDP growth slowed to less than 2%.
Recent data has bucked the trend though and last Friday’s strong employment report helps to support the US Federal Reserve’s view that the slowdown will be temporary.
Citi said that in addition to solid employment, consumer and business sentiment indicators look positive and construction activity in the housing sector is steady.
“Overall inflation remains relatively subdued, albeit at levels consistent with the range of the last quarter century,” they added.
If US economic data continues to strengthen and the EIS stays tracking towards positive territory, it bodes well for renewed strength in the US dollar in the second half of the year.
As the economic outlook brightens, Citi’s analysts now forecast that the yield on US 10-year notes will rise back towards 3%.
In addition, they expect the US Federal Reserve to start tapering its bond-purchasing program in September or October this year.
Higher US bond yields and a reduction in liquidity point towards a higher USD. Citi said that US dollar strength would be particularly evident against the traditional safe-haven currencies used to fund carry trades (Swiss franc and Japanese yen).
While verbal clashes between the US and North Korea this week have helped to drive fund flows into those two currencies, that risk-off sentiment has also weighed on the Aussie today, which a short time ago had fallen back below US79 cents.
Despite the unpredictability of geo-political events, if the US economy continues to strengthen in line with Citi’s estimates, it will likely boost the USD against other major currencies — and the Aussie’s recent stay above US80 cents will prove to have been a brief one.