Monday, August 31, 2020

Is AUD due for a correction after a sharp spike against the dollar over the last two trading sessions?

  • Dollar
  • AUD
  • RBA


Analysts’ Pick: Is AUD due for a correction after a sharp spike against the dollar over the last two trading sessions?

  • Don’t expect changes to the RBA’s monetary policy this week as focus remains on the fiscal stimulus side of things
  • AUD/USD may still have some downside with the central bank likely to revise its forecasts downwards to better reflect the strict lockdown restrictions in Victoria following a resurgence in Covid-19 cases in the area
  • ISM’s manufacturing PMI data will probably weigh on the greenback as well, with investors likely to remain cautiously optimistic of the economic recovery in the US
  • The downside may initially be limited to the day however, as we expect a rebound over the week in the form of a correction in the short-term

While no one expects any surprises from the Reserve Bank of Australia (RBA) at their decision on monetary policy tomorrow, investors will be focused on the central bank's economic forecasts for the country as it better accounts for the renewed lockdown restrictions in the state of Victoria since its last meeting. This would however, mean that the overall outlook for the movement for the Aussie remains unchanged, and is more likely to be driven by fiscal stimulus in Australia, as well as economic activity among its largest trade partners.

The spike in cases in Victoria forcing renewed lockdown restrictions is likely to have a bigger impact than initially expected


Economic activity in Australia has already began to show the impact of the renewed lockdown restrictions in the state of Victoria, with PMI data from the Commonwealth Bank of Australia stepping back into contractionary territory in both the manufacturing and services sectors. The same should also be expected when unemployment data for August is released later in the middle of September, and of Q2 GDP which the central bank expects to dip 6% in its baseline scenario. But with the lockdown restrictions escalating just before the last RBA meeting, we expect some downward revisions to the central bank's baseline forecast for the second half of the year. This seems especially true with a large spike in job losses in Victoria in August, with 27,600 people filing for unemployment benefits since June 26th, a 7.2% increase. The immediate impact was seen in consumer spending in the state as well, with Victorian household spending down around 30% year-to-date from flat mid-July. The key is here is that Victoria accounts for about 25% of the nation's GDP, meaning that the negative impact form the decision to reinforce strict lockdown restrictions was likely not fully accounted for in the RBA's forecasts.

August’s PMI data should concern the RBA on the actual impact of the lockdowns in Victoria


Also expected is continued dovishness from the RBA on both domestic and international economic conditions. The situation since the last monetary policy meeting has been little changed, only that it has become more apparent that the global economic recovery is starting to slowdown. This is evident in both the US and China, both of which are Australia's largest trading partner. While the surge in iron ore prices has helped lift the Australian economy, its upside looks to be limited with weakness in China's steel industry PMI for the third month in a row. This should consequently weigh on the Australian dollar over the longer-term as a result, and possibly introduce some downward pressure on the announcement of the central bank's monetary policy statement.

China’s Steel industry PMI has declined continuously for the past three months


Futures suggest the overall sentiment for iron ore prices is to fall over the next months, suggesting that upside may be limited moving forward


On the other hand, the dollar has been on a steady decline following the growing risk-on sentiment among investors which has been fuelled by traders as more economic data in the US shows economic activity improving in the short-term. In reality, the high rates of unemployment and signs of a slowing economic recovery has mostly been dismissed by market participants and sending the stock prices back into positive year-to-date performances. Tomorrow's ISM manufacturing PMI report for August looks to have the same effect, with some distortion from supplier deliveries although to a smaller degree when compared to previous months. Improvements in other indices looks likely to be the case as well, with exception for employment since it looks more likely that the sub-index will continue to show a contraction.

Jobless benefits data signal a continued but slower improvement in employment through August


We therefore see some downside for the Australian dollar, but with limited potential as the dollar may continue to weaken to new lows this week if fundamentals continue to show the US economy recovering and allow risk appetite to grow. AUD/USD may fall back below 0.7337 towards 0.7268's level. That said, it does appear the AUD/USD currency pair is due for a short downside correction after the steep bull run that we saw towards the end of last week. This would be a possible rebound later in the day or over the week back above the 0.7337 support if the dollar weakens as expected.

Technical Analysis:


The Aussie is trading at oversold levels, signalling that bears may be able to take over some control over the currency pair in the short-term as it trades near the highs of the ongoing uptrend. With fundamentals skewed towards the upside, technical imply that a correction is due for the Australian dollar in the short-term, possibly back towards 0.7268’s level before continuing back on its uptrend path. If we do see a bearish signal from MACD, we may see bears be able to retest the trend channel’s lows at around 0.7200’s level.

Support: 0.7337 / 0.7268 / 0.7176

Resistance: 0.7397 / 0.7500 / 0.7626

AUD/USD Chart (H4)