Australian Dollar Rally Loses Altitude as Oil and Yields Bite
The Australian dollar starts the week a little chastened and under pressure in the 0.7140-50 area, having surrendered close to a cent from last week's highs as a mix of familiar risks resurface and new ones emerge. Middle East oil supply risks have returned, with Saudi Arabia's East-West pipeline shut and efforts to establish a temporary Hormuz shipping route delayed. Risk appetite has also taken a hit on weekend calls from leading AI executives urging a slower pace of model development. The domestic calendar offers little this week beyond RBA Governor Bullock's testimony to Parliament Friday. Instead, markets will be driven offshore, where expected rate hikes from both the Fed and BoJ compete with an increasingly volatile Middle East for attention.
Australian Dollar Rally Loses Altitude as Oil and Yields Bite
The Australian dollar starts the week a little chastened and under pressure in the 0.7140-50 area, having surrendered close to a cent from last week's highs as a mix of familiar risks resurface and new ones emerge. Middle East oil supply risks have returned, with Saudi Arabia's East-West pipeline shut and efforts to establish a temporary Hormuz shipping route delayed. Risk appetite has also taken a hit on weekend calls from leading AI executives urging a slower pace of model development. The domestic calendar offers little this week beyond RBA Governor Bullock's testimony to Parliament Friday. Instead, markets will be driven offshore, where expected rate hikes from both the Fed and BoJ compete with an increasingly volatile Middle East for attention.
Australian Dollar's Grinding Orderly Rally Meets Reality
Benign conditions in the first half of last week saw the Australian dollar ink incremental fresh current up-leg highs daily, culminating in 0.7238 Wednesday. A double dose of hawkish messaging from RBA Assistant Governor Hunter and Deputy Governor Hauser gave fresh momentum to RBA rate hike expectations last week, raising the prospect of a pre-emptive insurance hike on 29 Sep. Copper prices were hitting all-time highs too, all contributing to a continuation of the Australian dollar's bullish momentum.
This favourable backdrop was unfolding within a well-defined 10wk rising channel that had lifted the Australian dollar by around US3½ cents. The Australian dollar periodically tested the channel's upper and lower bounds, but fresh catalysts repeatedly emerged, including higher commodity prices, Fed credibility concerns, questions about the coherence of US Treasury policy and upgraded RBA rate hike expectations.
Key Australian dollar crosses were also breaking new ground last week - AUD/EUR touched 21-month highs above 0.62, while AUD/NZD was challenging the very high 1.23s (also aided by a less hike committed RBNZ message).
Oil and Yields Bite Back
But these atmospherics changed by Thursday. Risk assets and risk appetite could not "ignore" the run-up in crude oil prices and US/global bonds anymore.
Yemen’s Iran-aligned Houthi forces launched attacks on Saudi facilities and captured strategic islands in the narrow Bab al-Mandab oil supply chokepoint. The East-West pipeline has been an important alternative path for Saudi crude, rerouting around 4m barrels per day (about 4% of global supply) to the Red Sea. But this pipeline is now out of service.
Brent crude squeezed almost USD10/bbl Thursday, retraced more than half that move Friday and is firming again to start the week: +$3.29 to $107.90/bbl. This saw long term US yields advance further last week, almost +20bp, the 10yr yield getting very close to the 5%-handle by week's end.
The Australian dollar is on the right side of the energy terms of trade shock but when it upsets risk conditions and creates a "growth scare" it trades as a risk currency first.
Crosses Run Different Races
Australian dollar crosses are running different races and moving at differnt speeds. AUD/EUR gave back the 0.62-handle on the late week washout in AUD/USD, but retains the bulk of its gains for the last couple months at 0.6180. AUD/CAD is holding to the 0.99-handle, and still knocking on parity's door.
AUD/NZD remains on the front foot too - having broken from sub-1.20-levels late August to new 13yr+ highs last week (1.2375). RBNZ signaling since they hiked rates on 2 Sep hasn't quite lived up to the aggressive rate hike cycle priced into markets.
AUD/JPY is running its own race: this cross has tumbled from 35yr highs near 115.00 on 28 August to 110.00, largely collateral damage from the steep reversal in USD/JPY in recent weeks, which in turn has been fostered a repricing toward a faster tempo of BoJ hikes, and overarching expectations that large foreign investors such as Japan's Government Pension Fund (GPIF) will be allocating more capital to domestic JGBs.
US Aug CPI Refuses to Cooperate
US August CPI on Friday clinched a Fed hike this week, the core rate rising 0.3% m/m, above expectations for a 0.2% m/m increase. This did not "meet" Jackson Hole Warsh's "moving towards 2% clearly and at sufficient speed" threshold. Pricing for this week's meeting shifted from around a 65% chance of hike to close to 90%.
Local fixed income yields are under pressure too. Australia of course enjoys much healthier fiscal/public debt metrics than G10 peers, but the overarching picture is inflationary. The economy is growing close to its speed limit around 2%, with household disposable income and spending unexpectedly decent in Q2, and an unprecedented data centre buildout unfolding.
The Fed Takes Centre Stage
Three key central bank meetings land this week: The Fed, the BoJ and the BoE.
Markets are confidently predicting a +25bp Fed hike after last week's Aug CPI failed to extend the nascent disinflation momentum that was in the Jun/Jul data. Never mind that most of the upside surprise in August CPI was contained to a handful of volatile categories and data reliability remains in doubt, with big chunks of the price basket now imputed. The Fed's updated dot plot projections likely show an upward shift, but will they chase market pricing which show +92bp in Fed hikes in total by the end of 2027?
US Treasury Secretary Bessent appears before the House Financial Services Committee for annual testimony on the international financial system. This ordinarily wouldn't be on our radar but after recent coordinated yen intervention with Japanese officials and expanded liquidity operations aimed at capping long term US yields we think this appearance could be some market moving detail.
Will Ueda Validate Market Pricing?
A BoJ rate hike is a foregone conclusion at the point. Markets have brought forward the timing of a follow up hike, pricing in a another +25bp before the year is out. Let's see if BoJ Governor Ueda validates that pricing. While BoJ officials spanning the hawk-dove spectrum have sounded more determined to push ahead with hikes, it's not a given that Ueda will follow through with more hawkish forward guidance too. The BoE is seen delivering a hawkish hold.
Australia's data and event calendar is limited to just RBA Governor Bullock's parliamentary appearance.
Tuesday
- China Aug property prices, retail sales, industrial production, fixed-asset investment
Wednesday
- UK Aug CPI
- US FOMC rate decision, Aug retail sales, business inventories
Thursday
- New Zealand Q2 GDP
- UK BOE rate decision
Friday
- RBA Governor Bullock parliamentary appearance
- Japan BoJ rate decision, Aug CPI
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