Under those dynamics, a weaker Aussie versus the greenback this year in 2023 has played into the hands of the Australian investors who bought U.S. equities as it has offset some of the drawdowns in the U.S. As such, unhedged AUD returns have been the clear winner so far this year.
However, AUD weakness may now be close to reaching an extreme. Remember, currency pair performance is often a function of growth and yield differentials.
When it comes to the USDAUD, The U.S.’s better-than-expected growth, supported by higher wages and a strong labour market, explains much of U.S. dollar’s strength. On the flip side, growth in China, Australia’s largest trading partner and the biggest consumer of its minerals, has disappointed this year, with little prospect of major policy support. This has weighed on growth in Australia, particularly in the resources and tourism markets.
Similarly, the Fed’s determination to move historically fast to tame inflation has put a spotlight on the RBA’s decision to pause in the middle of Australia’s hiking cycle. Australia’s inflation remains amongst the highest in the developed world, and if you look at real yields versus nominal yields, it’s clear that we still have some way to go compared to the U.S.
Any sign that the U.S. economy is not as robust as investors think, or that China’s economy can reverse a sluggish 2023 in the last quarter could help keep U.S. dollar strength in check.
On top of this, Australia’s still-high food costs as well as a persistent housing shortage, couple with an expected surge in immigration has the potential to fan inflation further. That may mean that the RBA’s 4 percentage points of increases since May last year could still be “underdone”.
Any consequent narrowing in yield differentials between the U.S. and Australia could leave the door open for a stronger Aussie dollar.
