Aussie dollar is caught in a tug of war

Institutional investors turned most bullish on the Australian dollar since March 2021 as the nation's central bank will likely keep interest rates at elevated levels.

Asset managers flipped to a net long position on the currency in the week ended 8 Oct, according to CFTC data. That came after they were bearish on the currency since Feb 2023.

The RBA will sit tight on rates until being confident that inflation is moving sustainably toward target, minutes of the last meeting showed, suggesting policy easing still remains some way off.

The minutes shine a spotlight on the board's policy conundrum at a time when Australia's inflation remains elevated and sticky while the rest of the world is slowly embarking on an easing cycle.

Financial market pricing implies the RBA's next move is down, with a cut seen early next year. A Bloomberg News survey showed that a majority of economists expect it to keep rates on hold this year.

The Aussie dollar rallied to the highest in 19 months in late September following China's stimulus announcement. However, it has pared some gains this month due to expectations of smaller Fed rate cuts.

“The position flip to longs … has to navigate a lot of consequential risks in coming weeks,” said Richard Franulovich, head of FX strategy at Westpac. He recommended going long at better levels towards 0.6630.

A Chinese gift

Consumer price increases slowed to a three-year low in August thanks to government rebates on electricity, while core inflation hit its lowest since early 2022. But both are high among developed economies.

Australia added more jobs than expected in August as the unemployment rate remained steady. Jobless rate needs to rise to ensure inflation's retreat continued, said the RBA.

The economy expanded by a modest 0.2% in Q2, unchanged for three straight quarters, slightly below expectations and underscoring persistent economic challenges

With two strong quarters expected in the second half of the year, evidence so far is scant that a rebound in consumer spending is materialising as households saved most tax cuts.

But China's dedicated efforts to pull itself out of a slump could benefit mining industry. Last week iron ore prices reached three-month highs on hopes that demand would improve significantly.

Home sales ticked up in some cities during the week-long holiday. However, the average daily transaction area of new homes fell 27% YoY during the period, according to the report which surveyed 25 major cities across China.

Private reports showed consumer sentiment down under climbed to a more than two-year high in October, while remaining deep in pessimistic territory, and business conditions rose to a four-month high.

Tariff man

The dollar climbed to the strongest level in two months as former President Donald Trump defended proposals to dramatically raise tariffs on foreign imports.

Just three weeks away from the election, markets need to price in prospects of a Trump win and currency markets will be directly affected by a fresh trade war, according to Amundi.

Trump and Harris are deadlocked in the latest national NBC News poll as Republicans came back home to support him after last month's rough debate and a subsequent polling deficit.

Still, underlining the poll is uncertainty about the election with 10% of voters saying they might change their minds and a sliver of unclaimed voters still on the fence.

Tariffs would stem capital flow overseas, potentially driving up inflation and interest rates. A prolonged trade war also stands to weigh on global risk sentiment –another tailwind for the dollar.

Barclay expects to see the biggest impacts against economies with which the US has a large trade deficit, like China. That could have been behind the urge to pump in tremendous liquidity in September.

Even countries like India and Vietnam could continue to benefit from accelerating supply chain diversification from China, their making up of the Australian export loss from China's pressures seems unlikely.

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.